Does Energisa (BVMF: ENGI3) have a healthy balance sheet?

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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. Like many other companies Energisa SA (BVMF: ENGI3) uses debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. 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 think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for Energisa

How much debt does Energisa have?

The graph below, which you can click for more details, shows that Energisa had a debt of R $ 19.0 billion in June 2021; about the same as the year before. However, he has 4.15 billion reais in cash offsetting this, which leads to a net debt of around 14.9 billion reais.

BOVESPA: ENGI3 History of debt to equity 25 October 2021

A look at the responsibilities of Energisa

Zooming in on the latest balance sheet data, we can see that Energisa had R $ 9.61 billion in liabilities due within 12 months and R $ 29.2 billion in liabilities due beyond. In return, he had 4.15 billion reais in cash and 6.41 billion reais in receivables due within 12 months. Its liabilities therefore total 28.2 billion reais more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R $ 18.3 billion society like a towering colossus of mere mortals. We therefore believe that shareholders should watch it closely. Ultimately, Energisa would likely need a major recapitalization if its creditors demanded repayment.

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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Energisa’s debt is 3.0 times its EBITDA, and its EBIT covers its interest expense 4.7 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Importantly, Energisa has increased its EBIT by 64% over the past twelve months, and this growth will make it easier to process its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Energisa can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Considering the past three years, Energisa has effectively recorded a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.

Our point of view

To be frank, Energisa’s conversion of EBIT to free cash flow and its history of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. It’s also worth noting that Energisa is part of the electric utility industry, which is often seen as quite defensive. Overall, we think it’s fair to say that Energisa has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for Energisa you need to be aware of it, and one of them is of concern.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

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 shares 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 material. Simply Wall St has no position in the mentioned stocks.

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