Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

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

How Much Debt Does Companhia de Eletricidade do Estado da Bahia - COELBA Carry?

The image below, which you can click on for greater detail, shows that at June 2023 Companhia de Eletricidade do Estado da Bahia - COELBA had debt of R$13.8b, up from R$13.0b in one year. However, because it has a cash reserve of R$632.0m, its net debt is less, at about R$13.2b.

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

Zooming in on the latest balance sheet data, we can see that Companhia de Eletricidade do Estado da Bahia - COELBA had liabilities of R$6.77b due within 12 months and liabilities of R$13.4b due beyond that. Offsetting these obligations, it had cash of R$632.0m as well as receivables valued at R$4.35b due within 12 months. So its liabilities total R$15.2b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of R$11.8b, we think shareholders really should watch Companhia de Eletricidade do Estado da Bahia - COELBA's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Companhia de Eletricidade do Estado da Bahia - COELBA's net debt to EBITDA ratio of 3.2, we think its super-low interest cover of 2.5 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. More concerning, Companhia de Eletricidade do Estado da Bahia - COELBA saw its EBIT drop by 7.6% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Companhia de Eletricidade do Estado da Bahia - COELBA will need earnings to service that debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Companhia de Eletricidade do Estado da Bahia - COELBA saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Companhia de Eletricidade do Estado da Bahia - COELBA's level of total liabilities and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. And even its EBIT growth rate fails to inspire much confidence. It's also worth noting that Companhia de Eletricidade do Estado da Bahia - COELBA is in the Electric Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Companhia de Eletricidade do Estado da Bahia - COELBA has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Be aware that Companhia de Eletricidade do Estado da Bahia - COELBA is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.