Stock Analysis

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

BIT:TRN
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 can see that Terna - Rete Elettrica Nazionale Società per Azioni (BIT:TRN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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

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

You can click the graphic below for the historical numbers, but it shows that Terna - Rete Elettrica Nazionale Società per Azioni had €10.7b of debt in September 2022, down from €12.2b, one year before. However, because it has a cash reserve of €2.07b, its net debt is less, at about €8.65b.

debt-equity-history-analysis
BIT:TRN Debt to Equity History December 28th 2022

A Look At Terna - Rete Elettrica Nazionale Società per Azioni's Liabilities

We can see from the most recent balance sheet that Terna - Rete Elettrica Nazionale Società per Azioni had liabilities of €5.56b falling due within a year, and liabilities of €8.13b due beyond that. On the other hand, it had cash of €2.07b and €565.6m worth of receivables due within a year. So it has liabilities totalling €11.1b more than its cash and near-term receivables, combined.

This is a mountain of leverage even relative to its gargantuan market capitalization of €14.2b. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Terna - Rete Elettrica Nazionale Società per Azioni has a debt to EBITDA ratio of 4.6, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 15.1 is very high, suggesting that the interest expense on the debt is currently quite low. Terna - Rete Elettrica Nazionale Società per Azioni grew its EBIT by 7.2% in the last year. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Terna - Rete Elettrica Nazionale Società per Azioni recorded negative free cash flow, in total. 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

Neither Terna - Rete Elettrica Nazionale Società per Azioni's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. 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. Taking the abovementioned factors together we do think Terna - Rete Elettrica Nazionale Società per Azioni's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Terna - Rete Elettrica Nazionale Società per Azioni you should be aware of, and 1 of them makes us a bit uncomfortable.

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.

Valuation is complex, but we're here to simplify it.

Discover if Terna might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.