Is ACEA (BIT:ACE) using too much debt?

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Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that ACEA SpA (BIT:ACE) uses debt in its business. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Discover our latest analysis for ACEA

What is ACEA’s debt?

As you can see below, ACEA had €5.31 billion in debt, as of June 2022, which is about the same as the previous year. You can click on the graph for more details. However, he has €627.9 million in cash that offsets this, resulting in a net debt of around €4.68 billion.

BIT: ACE Debt to Equity History August 17, 2022

How strong is ACEA’s balance sheet?

We can see from the most recent balance sheet that ACEA had liabilities of €2.95 billion due in one year, and liabilities of €5.50 billion due beyond. On the other hand, it had cash of €627.9 million and €1.99 billion in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €5.83 billion.

This deficit casts a shadow over the 2.95 billion euro enterprise, like a colossus towering above mere mortals. We would therefore watch his balance sheet closely, no doubt. After all, ACEA would likely need a major recapitalization if it were to pay its creditors today.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 4.4 ACEA has quite a significant amount of debt. On the positive side, its EBIT was 8.0 times its interest expense, and its net debt to EBITDA ratio was quite high, at 4.4. We have seen ACEA increase its EBIT by 6.7% over the last twelve months. While that barely brings us down, it’s a positive when it comes to debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine ACEA’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.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, ACEA has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

At first glance, ACEA’s conversion of EBIT to free cash flow left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. It should also be noted that companies in the integrated utility sector like ACEA generally use debt without a problem. Overall, it seems to us that ACEA’s balance sheet is really a risk for the company. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. 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 outside of the balance sheet. For example, we found 2 warning signs for ACEA (1 doesn’t suit us too much!) which you should be aware of before investing here.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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

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