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Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Entregie Company (NYSE: ETR) uses debt. But the real question is whether this debt makes the business risky.
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. 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.
See our latest review for Entergy
What is Entergy’s debt?
The image below, which you can click for more details, shows that as of June 2021, Entergy was in debt of $ 25.4 billion, up from $ 21.4 billion in a year. On the other hand, it has $ 686.9 million in cash, resulting in net debt of around $ 24.7 billion.
How strong is Entergy’s balance sheet?
According to the latest published balance sheet, Entergy had liabilities of US $ 3.80 billion due within 12 months and liabilities of US $ 41.0 billion due beyond 12 months. In compensation for these obligations, he had cash of US $ 686.9 million as well as receivables valued at US $ 1.44 billion due within 12 months. It therefore has liabilities totaling $ 42.7 billion more than its cash and short-term receivables combined.
This deficit casts a shadow over the $ 20.3 billion company, like a colossus towering over mere mortals. So we would be watching its record closely, without a doubt. After all, Entergy would likely need a major recapitalization if it were to pay its creditors today.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Entergy has a rather high debt to EBITDA ratio of 6.4, which suggests significant leverage. But the good news is that he enjoys a pretty comforting 6.0 times interest coverage, which suggests he can meet his obligations responsibly. Entergy increased its EBIT by 3.0% last year. It’s far from incredible, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Entergy’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Entergy has burned a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
To be frank, Entergy’s conversion of EBIT to free cash flow and its track record of controlling its total liabilities make us rather uncomfortable with its debt levels. That said, its ability to cover its interest costs with its EBIT is not that much of a concern. It’s also worth noting that electric utility companies like Entergy generally use debt without a problem. After looking at the data points discussed, we believe Entergy has too much debt. This kind of risk is acceptable to some, but it certainly does not float our boat. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Entergy (1 of which should not be ignored!) that you should know.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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 documents. Simply Wall St has no position in the mentioned stocks.
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