Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) Has A Somewhat Strained Balance Sheet

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.' 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. Importantly, Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View 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 December 2023 Companhia de Eletricidade do Estado da Bahia - COELBA had debt of R$14.8b, up from R$13.5b in one year. However, it does have R$974.0m in cash offsetting this, leading to net debt of about R$13.8b.

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

We can see from the most recent balance sheet that Companhia de Eletricidade do Estado da Bahia - COELBA had liabilities of R$6.96b falling due within a year, and liabilities of R$14.5b due beyond that. Offsetting this, it had R$974.0m in cash and R$4.54b in receivables that were due within 12 months. So it has liabilities totalling R$15.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the R$10.2b 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.

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). 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 has a debt to EBITDA ratio of 3.0 and its EBIT covered its interest expense 3.8 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. On a slightly more positive note, Companhia de Eletricidade do Estado da Bahia - COELBA grew its EBIT at 17% 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 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 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Companhia de Eletricidade do Estado da Bahia - COELBA burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Companhia de Eletricidade do Estado da Bahia - COELBA's level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. 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. Overall, it seems to us that Companhia de Eletricidade do Estado da Bahia - COELBA's balance sheet is really quite a risk to the business. 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. 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 potentially serious...

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.