Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Entergy Corporation (NYSE:ETR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, the more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Enterprise
How Much Debt Does Entergy Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2022 Entergy had US$28.6b of debt, an increase on US$25.7b, over one year. However, it also had US$701.6m in cash, and so its net debt is US$27.9b.
How Strong Is Entergy’s Balance Sheet?
The latest balance sheet data shows that Entergy had liabilities of US$5.36b due within a year, and liabilities of US$42.5b falling due after that. On the other hand, it had cash of US$701.6m and US$1.22b worth of receivables due within a year. So its liabilities total US$45.9b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$23.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, Entergy would likely require a major recapitalization if it had to pay its creditors today.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense ( its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the current interest expenses associated with that debt (with its interest cover ratio).
With a net debt to EBITDA ratio of 6.9, it’s fair to say Entergy does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 3.5 times, suggesting it can responsibly service its obligations. On a slightly more positive note, Entergy grew its EBIT by 19% over the last year, further increasing its ability to manage debt. When analyzing debt levels, the balance sheet is the obvious place to start. 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, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Entergy saw substantial negative free cash flow, in total. While investors are no doubt expecting the reversal of that situation in due course, it clearly does mean its use of debt is more risky.
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 on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should note that Electric Utilities industry companies like Entergy commonly do also use debt without problems. 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. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Case in point: We’ve spotted 4 warning signs for Entergy you should be aware of, and 1 of them is a bit concerning.
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.