These 4 measures indicate that the national network (LON: NG.) uses debt extensively

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Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that National Grid plc (LON:NG.) uses debt in his business. But should shareholders worry about its use of debt?

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

Discover our latest analysis for National Grid

What is National Grid’s net debt?

As you can see below, at the end of September 2021, National Grid had a debt of £44.0 billion, up from £32.0 billion a year ago. Click on the image for more details. However, he also had £2.75 billion in cash, so his net debt is £41.2 billion.

LSE: NG. History of Debt to Equity January 13, 2022

How healthy is National Grid’s balance sheet?

According to the latest published balance sheet, National Grid had liabilities of £23.9bn due within 12 months and liabilities of £44.4bn due beyond 12 months. On the other hand, it had cash of £2.75 billion and £3.03 billion of receivables due within a year. It therefore has liabilities totaling £62.5 billion more than its cash and short-term receivables, combined.

The deficiency here weighs heavily on Britain’s £38.1billion society, like a child struggling under the weight of a huge backpack full of books, his sports gear and a trumpet. We would therefore be watching his balance sheet closely, no doubt. Ultimately, National Grid would likely need a major recapitalization if its creditors were to demand repayment.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

National Grid has a fairly high debt to EBITDA ratio of 7.8, suggesting significant leverage. But the good news is that it has a pretty heartwarming 4.3x interest coverage, suggesting it can meet its obligations responsibly. On the other hand, National Grid increased its EBIT by 25% last year. If he can sustain that kind of improvement, his debt load will start to melt like glaciers in a warming world. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether National Grid can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, National Grid has had negative free cash flow, in total. Debt is generally more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.

Our point of view

To be frank, National Grid’s net debt to EBITDA ratio and its track record of keeping its total liabilities in check make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. It should also be noted that National Grid is part of the integrated utility sector, which is often seen as quite defensive. We are quite clear that we consider National Grid to be quite risky indeed, given the health of its balance sheet. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 3 warning signs for National Grid (1 is potentially serious) of which you should be aware.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% free, at present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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