Is CenterPoint Energy (NYSE:CNP) Using Too Much Debt?

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.' 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 CenterPoint Energy, Inc. (NYSE:CNP) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for CenterPoint Energy

What Is CenterPoint Energy's Net Debt?

As you can see below, at the end of June 2021, CenterPoint Energy had US$16.2b of debt, up from US$12.9b a year ago. Click the image for more detail. On the flip side, it has US$1.10b in cash leading to net debt of about US$15.1b.

A Look At CenterPoint Energy's Liabilities

According to the last reported balance sheet, CenterPoint Energy had liabilities of US$3.37b due within 12 months, and liabilities of US$24.2b due beyond 12 months. Offsetting this, it had US$1.10b in cash and US$999.0m in receivables that were due within 12 months. So it has liabilities totalling US$25.5b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$14.9b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, CenterPoint Energy 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CenterPoint Energy has a rather high debt to EBITDA ratio of 6.2 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.8 times, suggesting it can responsibly service its obligations. More concerning, CenterPoint Energy saw its EBIT drop by 3.7% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CenterPoint 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, CenterPoint 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.

Our View

On the face of it, CenterPoint Energy's conversion of EBIT to free cash flow 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 EBIT growth rate is not so bad. It's also worth noting that CenterPoint Energy is in the Integrated Utilities industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like CenterPoint Energy has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with CenterPoint Energy (including 1 which doesn't sit too well with us) .

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.

When trading CenterPoint Energy or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.