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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Alliant Energy Corporation (NASDAQ:LNT) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Alliant Energy's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Alliant Energy had debt of US$7.17b, up from US$6.53b in one year. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Alliant Energy's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Alliant Energy had liabilities of US$1.30b due within 12 months and liabilities of US$10.5b due beyond that. Offsetting these obligations, it had cash of US$54.0m as well as receivables valued at US$412.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$11.4b.
This is a mountain of leverage even relative to its gargantuan market capitalization of US$12.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 5.3, it's fair to say Alliant Energy does have a significant amount of debt. However, its interest coverage of 2.5 is reasonably strong, which is a good sign. Even more troubling is the fact that Alliant Energy actually let its EBIT decrease by 4.0% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Alliant Energy 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Alliant Energy burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
To be frank both Alliant Energy's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. And furthermore, its level of total liabilities also fails to instill confidence. It's also worth noting that Alliant Energy is in the Electric Utilities industry, which is often considered to be quite defensive. We're quite clear that we consider Alliant Energy to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 1 warning sign with Alliant Energy , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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