David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Enel SpA (BIT:ENEL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Enel's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 Enel had €67.6b of debt, an increase on €62.2b, over one year. On the flip side, it has €10.6b in cash leading to net debt of about €57.0b.
A Look At Enel's Liabilities
Zooming in on the latest balance sheet data, we can see that Enel had liabilities of €73.9b due within 12 months and liabilities of €90.1b due beyond that. On the other hand, it had cash of €10.6b and €21.1b worth of receivables due within a year. So it has liabilities totalling €132.3b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the €70.2b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Enel would likely require a major re-capitalisation if it had to pay its creditors today.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Enel has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 4.3 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Even more troubling is the fact that Enel actually let its EBIT decrease by 4.7% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Enel can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Enel reported free cash flow worth 2.2% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
We'd go so far as to say Enel's level of total liabilities was disappointing. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. It's also worth noting that Enel is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, it seems to us that Enel's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Enel has 4 warning signs (and 1 which can't be ignored) we think you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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