Does American Electric Power Company (NASDAQ: AEP) have a healthy balance sheet?



Howard Marks put 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 every investor practice that I know is worried. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, American Electric Power Company, Inc. (NASDAQ: AEP) is in debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider both liquidity and debt levels.

What is the debt of the American Electric Power Company?

As you can see below, at the end of September 2021, American Electric Power Company had $ 37.1 billion in debt, up from $ 32.5 billion a year ago. Click on the image for more details. However, given that it has a cash reserve of US $ 1.59 billion, its net debt is less, at around US $ 35.5 billion.

NasdaqGS: AEP History of debt to equity December 30, 2021

A look at the liabilities of American Electric Power Company

Zooming in on the latest balance sheet data, we can see that American Electric Power Company had a liability of US $ 9.95 billion due within 12 months and a liability of US $ 53.9 billion beyond. On the other hand, he had $ 1.59 billion in cash and $ 2.28 billion in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 59.9 billion.

Given that this deficit is actually greater than the company’s massive market cap of $ 44.6 billion, we think shareholders should really watch the American Electric Power Company’s debt levels, like a parent. watching his child ride a bike for the first time. In the event that the company were to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 5.8, it’s fair to say that American Electric Power Company has significant debt. However, its interest coverage of 2.9 is reasonably strong, which is a good sign. On a slightly more positive note, American Electric Power Company increased its EBIT to 14% over the past year, further increasing its ability to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether American Electric Power Company can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, American Electric Power Company has spent a lot of money. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

To be frank, American Electric Power Company’s net debt to EBITDA and track record of converting EBIT to free cash flow makes us rather uncomfortable with its leverage levels. But at least it’s decent enough to increase your EBIT; it’s encouraging. It should also be noted that companies in the electric utility industry like American Electric Power Company generally use debt with no problem. Overall, it seems to us that the balance sheet of American Electric Power Company is really very risky for the company. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Be aware that the American Electric Power Company displays 1 warning sign in our investment analysis , you must know…

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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