Is Terna - Rete Elettrica Nazionale Società per Azioni (BIT:TRN) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Terna - Rete Elettrica Nazionale Società per Azioni (BIT:TRN) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Terna - Rete Elettrica Nazionale Società per Azioni

What Is Terna - Rete Elettrica Nazionale Società per Azioni's Net Debt?

As you can see below, at the end of June 2021, Terna - Rete Elettrica Nazionale Società per Azioni had €11.8b of debt, up from €10.6b a year ago. Click the image for more detail. On the flip side, it has €1.98b in cash leading to net debt of about €9.77b.

How Strong Is Terna - Rete Elettrica Nazionale Società per Azioni's Balance Sheet?

We can see from the most recent balance sheet that Terna - Rete Elettrica Nazionale Società per Azioni had liabilities of €4.74b falling due within a year, and liabilities of €10.8b due beyond that. Offsetting these obligations, it had cash of €1.98b as well as receivables valued at €1.80b due within 12 months. So its liabilities total €11.8b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of €13.8b, so it does suggest shareholders should keep an eye on Terna - Rete Elettrica Nazionale Società per Azioni's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

As it happens Terna - Rete Elettrica Nazionale Società per Azioni has a fairly concerning net debt to EBITDA ratio of 5.5 but very strong interest coverage of 12.8. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably Terna - Rete Elettrica Nazionale Società per Azioni's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. 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 Terna - Rete Elettrica Nazionale Società per Azioni 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Terna - Rete Elettrica Nazionale Società per Azioni actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Terna - Rete Elettrica Nazionale Società per Azioni's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Electric Utilities industry companies like Terna - Rete Elettrica Nazionale Società per Azioni commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Terna - Rete Elettrica Nazionale Società per Azioni stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Terna - Rete Elettrica Nazionale Società per Azioni you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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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