Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) Use Of Debt Could Be Considered Risky

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) does use debt in its business. But the more important question is: how much risk is that debt creating?

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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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Companhia de Eletricidade do Estado da Bahia - COELBA's Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Companhia de Eletricidade do Estado da Bahia - COELBA had debt of R$16.6b, up from R$14.8b in one year. However, it also had R$1.55b in cash, and so its net debt is R$15.0b.

How Strong Is Companhia de Eletricidade do Estado da Bahia - COELBA's Balance Sheet?

The latest balance sheet data shows that Companhia de Eletricidade do Estado da Bahia - COELBA had liabilities of R$6.67b due within a year, and liabilities of R$17.2b falling due after that. On the other hand, it had cash of R$1.55b and R$4.06b worth of receivables due within a year. So it has liabilities totalling R$18.2b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the R$9.83b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Companhia de Eletricidade do Estado da Bahia - COELBA would likely require a major re-capitalisation if it had to pay its creditors today.

View our latest analysis for Companhia de Eletricidade do Estado da Bahia - COELBA

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). 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).

Companhia de Eletricidade do Estado da Bahia - COELBA's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Companhia de Eletricidade do Estado da Bahia - COELBA improved its EBIT by 5.6% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is Companhia de Eletricidade do Estado da Bahia - COELBA's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Companhia de Eletricidade do Estado da Bahia - COELBA actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Companhia de Eletricidade do Estado da Bahia - COELBA's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. We should also note that Electric Utilities industry companies like Companhia de Eletricidade do Estado da Bahia - COELBA commonly do use debt without problems. We're quite clear that we consider Companhia de Eletricidade do Estado da Bahia - COELBA to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Companhia de Eletricidade do Estado da Bahia - COELBA that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.