David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Public utility company SA (ATH: PPC) uses debt. But does this debt concern shareholders?

When Is Debt a Problem?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

Check out our latest review for Public Power

What is the debt of the public authorities?

The image below, which you can click for more details, shows that in June 2021, Public Power had debt of € 4.20 billion, up from € 3.95 billion in a year. However, it has € 1.19 billion in cash offsetting this, leading to net debt of around € 3.02 billion.

How solid is the balance sheet of public power?

The latest balance sheet data shows that Public Power had debt of € 3.56 billion maturing within one year, and debts of € 7.49 billion maturing thereafter. In return, he had € 1.19 billion in cash and € 1.76 billion in receivables due within 12 months. Its liabilities therefore amount to € 8.11 billion more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the 2.28 billion euro company, like a colossus towering over mere mortals. So we would be watching its record closely, without a doubt. After all, Public Power would likely need a major recapitalization if it were to pay its creditors today.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

While we’re not worried about Public Power’s 3.6 net debt to EBITDA ratio, we do think its ultra-low 1.4x interest coverage is a sign of high leverage. It appears the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. However, the bright side is that Public Power has achieved a positive EBIT of 127 million euros over the past twelve months, an improvement over the loss of the previous year. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Public Power can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Fortunately for all shareholders, Public Power has actually generated more free cash flow than EBIT over the past year. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

At first glance, Public Power’s interest coverage left us hesitant about the stock, and its total liability level was no more appealing than the lone restaurant empty on the busiest night of the year. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. It should also be noted that companies in the electric utility industry like Public Power generally use debt without a problem. Looking at the balance sheet and taking all of these factors into account, we think debt makes Public Power stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 2 warning signs for public authorities (1 doesn’t suit us very well!) Which you should be aware of before investing here.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

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