Is REN - Redes Energéticas Nacionais SGPS (ELI:RENE) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, REN - Redes Energéticas Nacionais, SGPS, S.A. (ELI:RENE) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for REN - Redes Energéticas Nacionais SGPS

What Is REN - Redes Energéticas Nacionais SGPS's Debt?

The chart below, which you can click on for greater detail, shows that REN - Redes Energéticas Nacionais SGPS had €2.60b in debt in September 2024; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

A Look At REN - Redes Energéticas Nacionais SGPS' Liabilities

We can see from the most recent balance sheet that REN - Redes Energéticas Nacionais SGPS had liabilities of €1.53b falling due within a year, and liabilities of €2.25b due beyond that. On the other hand, it had cash of €33.0m and €304.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.45b.

This deficit casts a shadow over the €1.65b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, REN - Redes Energéticas Nacionais SGPS would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 5.4, it's fair to say REN - Redes Energéticas Nacionais SGPS does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 6.3 times, suggesting it can responsibly service its obligations. The bad news is that REN - Redes Energéticas Nacionais SGPS saw its EBIT decline by 11% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine REN - Redes Energéticas Nacionais SGPS's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, REN - Redes Energéticas Nacionais SGPS created free cash flow amounting to 9.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, REN - Redes Energéticas Nacionais SGPS's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its interest cover is not so bad. It's also worth noting that REN - Redes Energéticas Nacionais SGPS is in the Integrated Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think REN - Redes Energéticas Nacionais SGPS has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 3 warning signs for REN - Redes Energéticas Nacionais SGPS (2 are potentially serious!) that you should be aware of before investing here.

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.

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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.