EDP - Energias do Brasil (BVMF:ENBR3) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, EDP - Energias do Brasil S.A. (BVMF:ENBR3) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for EDP - Energias do Brasil

What Is EDP - Energias do Brasil's Debt?

As you can see below, at the end of March 2020, EDP - Energias do Brasil had R$8.49b of debt, up from R$7.52b a year ago. Click the image for more detail. On the flip side, it has R$2.49b in cash leading to net debt of about R$5.99b.

How Healthy Is EDP - Energias do Brasil's Balance Sheet?

According to the last reported balance sheet, EDP - Energias do Brasil had liabilities of R$5.48b due within 12 months, and liabilities of R$11.2b due beyond 12 months. Offsetting this, it had R$2.49b in cash and R$3.54b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$10.7b.

When you consider that this deficiency exceeds the company's R$10.4b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

EDP - Energias do Brasil's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 1.0k times, makes us even more comfortable. Also relevant is that EDP - Energias do Brasil has grown its EBIT by a very respectable 23% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine EDP - Energias do Brasil's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, EDP - Energias do Brasil's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

EDP - Energias do Brasil's interest cover was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. It's also worth noting that EDP - Energias do Brasil is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about EDP - Energias do Brasil's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for EDP - Energias do Brasil you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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