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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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

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

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Companhia de Eletricidade do Estado da Bahia - COELBA had R$14.9b of debt, an increase on R$14.1b, over one year. However, it also had R$1.41b in cash, and so its net debt is R$13.5b.

How Strong 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$7.81b due within 12 months and liabilities of R$14.0b due beyond that. Offsetting these obligations, it had cash of R$1.41b as well as receivables valued at R$4.18b due within 12 months. So it has liabilities totalling R$16.2b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the R$9.77b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Companhia de Eletricidade do Estado da Bahia - COELBA would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Companhia de Eletricidade do Estado da Bahia - COELBA's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 2.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. On a slightly more positive note, Companhia de Eletricidade do Estado da Bahia - COELBA grew its EBIT at 11% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by 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 conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Companhia de Eletricidade do Estado da Bahia - COELBA (of which 1 can't be ignored!) you should know about.

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.