Does Meridian Energy (NZSE:MEL) have a healthy balance sheet?

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Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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. Above all, Meridian Energy Limited (NZSE:MEL) is in debt. But should shareholders worry about its use of debt?

What risk does debt carry?

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. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

Our analysis indicates that MEL is potentially undervalued!

What is Meridian Energy’s debt?

The image below, which you can click on for more details, shows that Meridian Energy had NZ$1.16 billion in debt at the end of June 2022, a reduction from NZ$1.68 billion. New Zealand dollars over one year. However, he has NZ$363.0 million in cash to offset this, resulting in a net debt of approximately NZ$800.0 million.

NZSE: MEL Debt to Equity History November 9, 2022

How strong is Meridian Energy’s balance sheet?

According to the latest published balance sheet, Meridian Energy had liabilities of NZ$726.0 million due within 12 months and liabilities of NZ$3.12 billion due beyond 12 months. In return, it had NZ$363.0 million in cash and NZ$432.0 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its (short-term) cash and receivables of NZ$3.05 billion.

Meridian Energy has a market capitalization of NZ$12.1 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Meridian Energy has net debt of just 0.96 times EBITDA, suggesting it could increase leverage without breaking a sweat. And remarkably, although she has net debt, she has actually received more interest in the last twelve months than she has had to pay. So it’s fair to say he can handle debt like a hotshot teppanyaki chef handles the kitchen. But the flip side is that Meridian Energy has seen its EBIT drop 2.9% over the past year. This type of decline, if it continues, will obviously make the debt more difficult to manage. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Meridian Energy’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Meridian Energy has recorded free cash flow of 73% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

Meridian Energy’s interest cover suggests they can manage their debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But, on a darker note, we are a bit concerned about its EBIT growth rate. Given all of this data, it seems to us that Meridian Energy is taking a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 2 warning signs for Meridian Energy which you should be aware of before investing here.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

Valuation is complex, but we help make it simple.

Find out if meridian energy is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.

See the free analysis

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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