Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Consolidated Edison, Inc. (NYSE:ED) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Consolidated Edison Carry?
As you can see below, at the end of June 2019, Consolidated Edison had US$20.6b of debt, up from US$17.9b a year ago. Click the image for more detail. However, it also had US$831.0m in cash, and so its net debt is US$19.8b.
How Strong Is Consolidated Edison's Balance Sheet?
We can see from the most recent balance sheet that Consolidated Edison had liabilities of US$5.97b falling due within a year, and liabilities of US$31.8b due beyond that. Offsetting this, it had US$831.0m in cash and US$1.95b in receivables that were due within 12 months. So it has liabilities totalling US$35.0b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's huge US$29.0b market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Consolidated Edison has a debt to EBITDA ratio of 4.9 and its EBIT covered its interest expense 2.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Consolidated Edison's EBIT was pretty flat over the last year, which isn't ideal given the debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Consolidated Edison'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Consolidated Edison burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
We'd go so far as to say Consolidated Edison's conversion of EBIT to free cash flow was disappointing. But at least its EBIT growth rate is not so bad. We should also note that Integrated Utilities industry companies like Consolidated Edison commonly do use debt without problems. Overall, it seems to us that Consolidated Edison's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. Given Consolidated Edison has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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