Does A2A (BIT:A2A) Have A Healthy Balance Sheet?

Simply Wall St · 06/03 11:41

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies A2A S.p.A. (BIT:A2A) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for A2A

How Much Debt Does A2A Carry?

The image below, which you can click on for greater detail, shows that A2A had debt of €6.19b at the end of March 2024, a reduction from €7.07b over a year. On the flip side, it has €1.41b in cash leading to net debt of about €4.78b.

BIT:A2A Debt to Equity History June 3rd 2024

How Strong Is A2A's Balance Sheet?

We can see from the most recent balance sheet that A2A had liabilities of €6.20b falling due within a year, and liabilities of €6.70b due beyond that. Offsetting these obligations, it had cash of €1.41b as well as receivables valued at €3.55b due within 12 months. So its liabilities total €7.95b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's €6.04b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

We'd say that A2A's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its commanding EBIT of 10.9 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, A2A grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its 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 A2A'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 always check how much of that EBIT is translated into free cash flow. Over the last three years, A2A reported free cash flow worth 14% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While A2A's level of total liabilities has us nervous. For example, its EBIT growth rate and interest cover give us some confidence in its ability to manage its debt. We should also note that Integrated Utilities industry companies like A2A commonly do use debt without problems. We think that A2A's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for A2A (1 is concerning!) that you should be aware of before investing here.

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.