Is Energisa (BVMF:ENGI3) using too much debt?

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We notice that Energisa SA (BVMF:ENGI3) has debt on its balance sheet. 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 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 common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

See our latest review for Energisa

How much debt does Energisa bear?

As you can see below, at the end of September 2021, Energisa had a debt of R$21.0 billion, compared to R$19.3 billion a year ago. Click on the image for more details. However, he has 4.38 billion reais in cash to offset this, resulting in a net debt of around 16.6 billion reais.

BOVESPA:ENGI3 Debt to equity Historical 24 January 2022

A look at Energisa’s responsibilities

The latest balance sheet data shows that Energisa had liabilities of R$10.9 billion due within one year, and liabilities of R$30.9 billion falling due thereafter. On the other hand, it had a cash position of R$4.38 billion and R$7.68 billion in receivables due within one year. It therefore has liabilities totaling 29.8 billion reais more than its cash and short-term receivables, combined.

The deficiency here weighs heavily on the company itself of 17.3 billion reais, like a child struggling under the weight of a huge backpack full of books, his sports equipment and a trumpet . So we definitely think shareholders need to watch this one closely. After all, Energisa would likely need a major recapitalization if it were to pay its creditors today.

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.

Energisa has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 4.7 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. Above all, Energisa has increased its EBIT by 42% in the last twelve months, and this growth will make it easier to manage 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, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Energisa has actually had a cash outflow, overall. 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, Energisa’s conversion of EBIT to free cash flow and its track record of keeping its total liabilities under control makes us rather uncomfortable with its level of leverage. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. It should also be noted that Energisa belongs to the electric utility sector, which is often considered quite defensive. Overall, we think it’s fair to say that Energisa has enough debt that there are real risks around the balance sheet. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, Energisa has 4 warning signs (and 2 that can’t be ignored) that we think you should know about.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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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