Is Ampla Energia e Serviços (BVMF:CBEE3) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Ampla Energia e Serviços S.A. (BVMF:CBEE3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ampla Energia e Serviços

How Much Debt Does Ampla Energia e Serviços Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Ampla Energia e Serviços had debt of R$4.63b, up from R$4.39b in one year. However, it also had R$657.8m in cash, and so its net debt is R$3.98b.

How Healthy Is Ampla Energia e Serviços' Balance Sheet?

The latest balance sheet data shows that Ampla Energia e Serviços had liabilities of R$4.15b due within a year, and liabilities of R$4.35b falling due after that. Offsetting this, it had R$657.8m in cash and R$2.57b in receivables that were due within 12 months. So it has liabilities totalling R$5.28b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's R$3.91b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 5.5 hit our confidence in Ampla Energia e Serviços like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Ampla Energia e Serviços's EBIT was down 61% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Ampla Energia e Serviços's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last three years, Ampla Energia e Serviços saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Ampla Energia e Serviços's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its level of total liabilities fails to inspire much confidence. It's also worth noting that Ampla Energia e Serviços is in the Electric Utilities industry, which is often considered to be quite defensive. Considering all the factors previously mentioned, we think that Ampla Energia e Serviços really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Ampla Energia e Serviços you should be aware of, and 1 of them shouldn't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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