Does Societatea Energetica Electrica (BVB:EL) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Societatea Energetica Electrica S.A. (BVB:EL) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Societatea Energetica Electrica

What Is Societatea Energetica Electrica's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Societatea Energetica Electrica had debt of RON3.84b, up from RON2.33b in one year. However, because it has a cash reserve of RON108.6m, its net debt is less, at about RON3.74b.

How Strong Is Societatea Energetica Electrica's Balance Sheet?

According to the last reported balance sheet, Societatea Energetica Electrica had liabilities of RON5.64b due within 12 months, and liabilities of RON1.18b due beyond 12 months. On the other hand, it had cash of RON108.6m and RON4.55b worth of receivables due within a year. So its liabilities total RON2.16b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RON3.23b, so it does suggest shareholders should keep an eye on Societatea Energetica Electrica's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Societatea Energetica Electrica has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.9 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We also note that Societatea Energetica Electrica improved its EBIT from a last year's loss to a positive RON990m. 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 Societatea Energetica Electrica'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Societatea Energetica Electrica burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Societatea Energetica Electrica's conversion of EBIT to free cash flow was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. We should also note that Electric Utilities industry companies like Societatea Energetica Electrica commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that Societatea Energetica Electrica's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should be aware of the 2 warning signs we've spotted with Societatea Energetica Electrica .

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. 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.