Warren Buffett famously said, “Volatility is far from synonymous with risk.” It’s only natural to consider a company’s balance sheet when examining how risky it is, since debt is often at play when a company collapses. We note that Entergy Corporation (NYSE:ETR) has debt on its balance sheet. But the real question is whether that debt makes the company risky.
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it’s at their mercy. Ultimately, if the company fails to meet its legal obligations to pay down debt, shareholders could get away with nothing. However, a more common (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to get the debt under control. The benefit of leverage, of course, is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high returns. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.
Check out our latest analysis for Entergy
How much debt does Entergy have?
You can click on the chart below to see historical numbers, but it shows that Entergy had $28.6 billion in debt as of March 2022, up from $25.7 billion above corresponds to one year. However, it also had $701.6 million in cash on hand, making its net debt $27.9 billion.
How strong is Entergy’s balance sheet?
The latest balance sheet data shows that Entergy had $5.36 billion in liabilities maturing within one year and $42.5 billion in liabilities maturing thereafter. On the other hand, it had $701.6 million in cash and $1.22 billion in accounts receivable that were due within a year. So its liabilities are $45.9 billion more than the combination of cash and short-term receivables.
That deficiency weighs heavily on the $23.4 billion company itself, like a child struggling under the weight of a giant backpack full of books, its gym gear, and a trumpet. So we would no doubt be watching his record closely. After all, Entergy would likely need a major recapitalization if it had to pay its creditors today.
To estimate a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its interest expense (its interest coverage). The advantage of this approach is that we consider both the absolute level of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio).
With a net debt-to-EBITDA ratio of 6.9, it’s fair to say that Entergy has significant debt. But the good news is that it offers a fairly reassuring interest rate coverage of 3.5, suggesting it can service its commitments responsibly. On a more positive note, Entergy grew its EBIT by 19% over the past year, further improving its ability to manage debt. When analyzing debt, the balance sheet is the obvious place to start. But it’s future earnings above all else that will determine Entergy’s ability to maintain a healthy balance sheet going forward. So if you want to see what the experts think, you might be interested in this free report on analyst earnings forecasts.
After all, a business needs free cash flow to pay off debt; Accounting profits just don’t cut it. So we really need to see if that EBIT translates into free cash flow to match. Overall, for the past three years, Entergy has had significant negative free cash flow. While investors are no doubt expecting a reversal of this situation in due course, it clearly means that using debt is riskier.
At first glance, Entergy’s conversion of EBIT to free cash flow left us hesitant about the stock, and the level of total debt was no more enticing than that one empty restaurant on the busiest night of the year. On a positive note, however, the EBIT growth rate bodes well and makes us more optimistic. We should also note that electric utility companies like Entergy commonly use debt without any problems. Overall, Entergy’s balance sheet seems to us to be quite a risk for the company. So we’re almost as wary of this stock as a hungry kitten is about to fall into its owner’s fishpond: bite once, shy twice, as the saying goes. Undoubtedly, we learn most about debt from the balance sheet. However, the entire investment risk is not on the balance sheet – far from it. Case in point: We discovered it 4 Warning Signs of Entergy You should be aware of this, and one of them is a bit concerning.
If you’re interested in investing in companies that can turn a profit without the burden of debt, then check this out free List of growing companies that have net cash on their balance sheets.
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