U.S. Markets closed

Is Xcel Energy (NASDAQ:XEL) Using Too Much Debt?

Simply Wall St

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Xcel Energy Inc. (NASDAQ:XEL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Xcel Energy

How Much Debt Does Xcel Energy Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 Xcel Energy had US$18.2b of debt, an increase on US$16.8b, over one year. On the flip side, it has US$398.0m in cash leading to net debt of about US$17.8b.

NasdaqGS:XEL Historical Debt, September 26th 2019

A Look At Xcel Energy's Liabilities

The latest balance sheet data shows that Xcel Energy had liabilities of US$5.06b due within a year, and liabilities of US$31.2b falling due after that. Offsetting these obligations, it had cash of US$398.0m as well as receivables valued at US$1.38b due within 12 months. So it has liabilities totalling US$34.4b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's huge US$34.1b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Xcel Energy's debt to EBITDA ratio (4.9) suggests that it uses some debt, its interest cover is very weak, at 2.5, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Another concern for investors might be that Xcel Energy's EBIT fell 12% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Xcel Energy can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Xcel Energy burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Mulling over Xcel Energy's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. And even its EBIT growth rate fails to inspire much confidence. We should also note that Electric Utilities industry companies like Xcel Energy commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Xcel Energy has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about Xcel Energy's debt levels, it seems only prudent to check if insiders have been ditching the stock.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.