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 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. As with many other companies Consolidated Edison, Inc. (NYSE:ED) makes use of debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Consolidated Edison's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 Consolidated Edison had US$24.1b of debt, an increase on US$23.1b, over one year. However, it does have US$1.07b in cash offsetting this, leading to net debt of about US$23.1b.
How Healthy Is Consolidated Edison's Balance Sheet?
The latest balance sheet data shows that Consolidated Edison had liabilities of US$5.56b due within a year, and liabilities of US$37.3b falling due after that. Offsetting these obligations, it had cash of US$1.07b as well as receivables valued at US$2.81b due within 12 months. So its liabilities total US$39.0b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's huge US$26.7b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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.
With a net debt to EBITDA ratio of 5.1, it's fair to say Consolidated Edison does have a significant amount of debt. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. Given the debt load, it's hardly ideal that Consolidated Edison's EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Consolidated Edison 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Consolidated Edison burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Consolidated Edison's level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. We should also note that Integrated Utilities industry companies like Consolidated Edison commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Consolidated Edison 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 4 warning signs for Consolidated Edison (1 shouldn't be ignored) you should be aware of.
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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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.
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