These 4 Measures Indicate That Terna - Rete Elettrica Nazionale Società per Azioni (BIT:TRN) Is Using Debt Extensively

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. Importantly, Terna - Rete Elettrica Nazionale Società per Azioni (BIT:TRN) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

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

How Much Debt Does Terna - Rete Elettrica Nazionale Società per Azioni Carry?

You can click the graphic below for the historical numbers, but it shows that Terna - Rete Elettrica Nazionale Società per Azioni had €10.6b of debt in March 2022, down from €11.6b, one year before. On the flip side, it has €1.95b in cash leading to net debt of about €8.68b.

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

Zooming in on the latest balance sheet data, we can see that Terna - Rete Elettrica Nazionale Società per Azioni had liabilities of €3.89b due within 12 months and liabilities of €9.18b due beyond that. Offsetting these obligations, it had cash of €1.95b as well as receivables valued at €472.3m due within 12 months. So it has liabilities totalling €10.6b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of €15.1b, so it does suggest shareholders should keep an eye on Terna - Rete Elettrica Nazionale Società per Azioni's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Terna - Rete Elettrica Nazionale Società per Azioni's net debt is 4.7 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 13.6 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. We saw Terna - Rete Elettrica Nazionale Società per Azioni grow its EBIT by 6.5% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Terna - Rete Elettrica Nazionale Società per Azioni saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Mulling over Terna - Rete Elettrica Nazionale Società per Azioni's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that Terna - Rete Elettrica Nazionale Società per Azioni is in the Electric Utilities industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Terna - Rete Elettrica Nazionale Società per Azioni's debt is making it 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. For example, we've discovered 2 warning signs for Terna - Rete Elettrica Nazionale Società per Azioni (1 shouldn't be ignored!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.