Is Entergy (NYSE:ETR) using too much debt?

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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. Mostly, Entergy Company (NYSE:ETR) is in debt. But the more important question is: what risk does this debt create?

When is debt a problem?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for Entergy

What is Entergy’s net debt?

As you can see below, at the end of December 2021, Entergy had $27.0 billion in debt, up from $24.0 billion a year ago. Click on the image for more details. Net debt is about the same, since she doesn’t have a lot of cash.

NYSE:ETR Debt to Equity April 3, 2022

A look at Entergy’s responsibilities

According to the last published balance sheet, Entergy had liabilities of US$6.19 billion due within 12 months and liabilities of US$41.3 billion due beyond 12 months. On the other hand, it had liquidities of 442.6 million dollars and 1.37 billion dollars of receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by $45.7 billion.

This deficit casts a shadow over the $24.4 billion company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Entergy would likely need a major recapitalization if its creditors were to demand repayment.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount 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 6.7, it’s fair to say that Entergy has significant debt. However, its interest coverage of 4.7 is reasonably strong, which is a good sign. We note that Entergy has grown its EBIT by 22% over the past year, which should make it easier to pay down debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Entergy’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Entergy has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.

Our point of view

To be frank, Entergy’s EBIT to free cash flow conversion and track record of keeping its total liabilities under control makes us rather uncomfortable with its level of leverage. But at least it’s decent enough to increase its EBIT; it’s encouraging. It should also be noted that Entergy belongs to the electric utility sector, which is often considered quite defensive. Overall, it seems to us that Entergy’s balance sheet is really a risk for the company. We are therefore almost as wary of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 5 warning signs for Entergy (1 of which should not be ignored!) that you should know.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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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