Innergex Renewable Energy (TSE:INE) Use Of Debt Could Be Considered Risky

Simply Wall St · 10/15 13:04

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Innergex Renewable Energy Inc. (TSE:INE) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Innergex Renewable Energy

What Is Innergex Renewable Energy's Net Debt?

As you can see below, at the end of June 2024, Innergex Renewable Energy had CA$6.37b of debt, up from CA$5.98b a year ago. Click the image for more detail. On the flip side, it has CA$171.5m in cash leading to net debt of about CA$6.20b.

debt-equity-history-analysis
TSX:INE Debt to Equity History October 15th 2024

How Healthy Is Innergex Renewable Energy's Balance Sheet?

According to the last reported balance sheet, Innergex Renewable Energy had liabilities of CA$962.1m due within 12 months, and liabilities of CA$6.67b due beyond 12 months. On the other hand, it had cash of CA$171.5m and CA$247.6m worth of receivables due within a year. So it has liabilities totalling CA$7.22b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CA$1.93b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Innergex Renewable Energy would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Innergex Renewable Energy shareholders face the double whammy of a high net debt to EBITDA ratio (9.0), and fairly weak interest coverage, since EBIT is just 0.97 times the interest expense. This means we'd consider it to have a heavy debt load. On a slightly more positive note, Innergex Renewable Energy grew its EBIT at 13% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Innergex Renewable 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Innergex Renewable Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Innergex Renewable Energy's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. After considering the datapoints discussed, we think Innergex Renewable Energy has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Innergex Renewable Energy (1 is concerning) you should be aware of.

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.