Atlantica Sustainable Infrastructure (NASDAQ:AY) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Atlantica Sustainable Infrastructure plc (NASDAQ:AY) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Atlantica Sustainable Infrastructure

What Is Atlantica Sustainable Infrastructure's Debt?

You can click the graphic below for the historical numbers, but it shows that Atlantica Sustainable Infrastructure had US$5.82b of debt in June 2022, down from US$6.67b, one year before. However, it also had US$853.1m in cash, and so its net debt is US$4.96b.

How Strong Is Atlantica Sustainable Infrastructure's Balance Sheet?

The latest balance sheet data shows that Atlantica Sustainable Infrastructure had liabilities of US$569.7m due within a year, and liabilities of US$7.00b falling due after that. On the other hand, it had cash of US$853.1m and US$265.9m worth of receivables due within a year. So it has liabilities totalling US$6.46b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$3.98b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Atlantica Sustainable Infrastructure would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.88 times and a disturbingly high net debt to EBITDA ratio of 7.5 hit our confidence in Atlantica Sustainable Infrastructure like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Atlantica Sustainable Infrastructure saw its EBIT tank 24% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Atlantica Sustainable Infrastructure 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 we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Atlantica Sustainable Infrastructure actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both Atlantica Sustainable Infrastructure's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. After considering the datapoints discussed, we think Atlantica Sustainable Infrastructure 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Atlantica Sustainable Infrastructure that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.