REN - Redes Energéticas Nacionais SGPS (ELI:RENE) Has A Somewhat Strained Balance Sheet

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 REN - Redes Energéticas Nacionais, SGPS, S.A. (ELI:RENE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for REN - Redes Energéticas Nacionais SGPS

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

You can click the graphic below for the historical numbers, but it shows that REN - Redes Energéticas Nacionais SGPS had €2.65b of debt in March 2022, down from €2.82b, one year before. However, it does have €555.0m in cash offsetting this, leading to net debt of about €2.10b.

How Strong Is REN - Redes Energéticas Nacionais SGPS' Balance Sheet?

We can see from the most recent balance sheet that REN - Redes Energéticas Nacionais SGPS had liabilities of €1.04b falling due within a year, and liabilities of €3.28b due beyond that. Offsetting this, it had €555.0m in cash and €436.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.33b.

This deficit casts a shadow over the €1.92b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. 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.

REN - Redes Energéticas Nacionais SGPS has a debt to EBITDA ratio of 4.8 and its EBIT covered its interest expense 5.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly REN - Redes Energéticas Nacionais SGPS's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, REN - Redes Energéticas Nacionais SGPS actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We'd go so far as to say REN - Redes Energéticas Nacionais SGPS's level of total liabilities was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We should also note that Integrated Utilities industry companies like REN - Redes Energéticas Nacionais SGPS commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that REN - Redes Energéticas Nacionais SGPS'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. 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. For example - REN - Redes Energéticas Nacionais SGPS has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.