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. Importantly, NextEra Energy, Inc. (NYSE:NEE) does carry debt. But the real question is whether this debt is making the company risky.
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is NextEra Energy’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 NextEra Energy had US$55.3b of debt, an increase on US$48.3b, over one year. And it doesn’t have much cash, so its net debt is about the same.
A Look At NextEra Energy’s Liabilities
Zooming in on the latest balance sheet data, we can see that NextEra Energy had liabilities of US$20.5b due within 12 months and liabilities of US$74.0b due beyond that. Offsetting these obligations, it had cash of US$692.0m as well as receivables valued at US$3.86b due within 12 months. So its liabilities total US$89.9b more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because NextEra Energy is worth a massive US$168.9b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
NextEra Energy has a rather high debt to EBITDA ratio of 7.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.8 times, suggesting it can responsibly service its obligations. Worse, NextEra Energy’s EBIT was down 45% over the last year. If earnings keep going like that over the long term, it has a snowball’s chance in hell of paying off that debt. 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 NextEra Energy’s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, NextEra Energy saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both NextEra Energy’s conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn’t such a worry. It’s also worth noting that NextEra Energy is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, it seems to us that NextEra Energy’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.