Here's Why Entergy (NYSE:ETR) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Entergy Corporation (NYSE:ETR) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Entergy

What Is Entergy's Net Debt?

As you can see below, Entergy had US$28.4b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$1.29b in cash, and so its net debt is US$27.1b.

A Look At Entergy's Liabilities

We can see from the most recent balance sheet that Entergy had liabilities of US$6.88b falling due within a year, and liabilities of US$40.0b due beyond that. Offsetting this, it had US$1.29b in cash and US$1.29b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$44.3b.

This deficit casts a shadow over the US$23.3b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Entergy would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Entergy has a rather high debt to EBITDA ratio of 5.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.2 times, suggesting it can responsibly service its obligations. The good news is that Entergy grew its EBIT a smooth 43% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Entergy's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. During the last three years, Entergy 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, Entergy'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 it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that Entergy is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, it seems to us that Entergy's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Entergy (of which 1 makes us a bit uncomfortable!) you should know about.

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.

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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.