Edison International (NYSE:EIX) Use Of Debt Could Be Considered Risky

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, Edison International (NYSE:EIX) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Edison International

What Is Edison International's Debt?

As you can see below, at the end of September 2022, Edison International had US$30.3b of debt, up from US$27.2b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Edison International's Balance Sheet?

According to the last reported balance sheet, Edison International had liabilities of US$10.8b due within 12 months, and liabilities of US$48.6b due beyond 12 months. On the other hand, it had cash of US$232.0m and US$3.56b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$55.6b.

This deficit casts a shadow over the US$26.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Edison International would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Edison International has a rather high debt to EBITDA ratio of 5.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.5 times, suggesting it can responsibly service its obligations. More concerning, Edison International saw its EBIT drop by 6.3% 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 Edison International 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Edison International saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Edison International'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. And even its interest cover fails to inspire much confidence. It's also worth noting that Edison International is in the Electric Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Edison International has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For instance, we've identified 3 warning signs for Edison International (2 are concerning) you should be aware of.

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.