Is Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Companhia de Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

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

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

As you can see below, at the end of September 2022, Companhia de Eletricidade do Estado da Bahia - COELBA had R$14.1b of debt, up from R$9.95b a year ago. Click the image for more detail. On the flip side, it has R$1.37b in cash leading to net debt of about R$12.7b.

A Look At Companhia de Eletricidade do Estado da Bahia - COELBA's Liabilities

The latest balance sheet data shows that Companhia de Eletricidade do Estado da Bahia - COELBA had liabilities of R$5.17b due within a year, and liabilities of R$15.2b falling due after that. Offsetting this, it had R$1.37b in cash and R$4.00b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$15.0b.

Given this deficit is actually higher than the company's market capitalization of R$10.2b, 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. 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Companhia de Eletricidade do Estado da Bahia - COELBA's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 4.1 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. On a lighter note, we note that Companhia de Eletricidade do Estado da Bahia - COELBA grew its EBIT by 21% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. There's no doubt that we learn most about debt from the balance sheet. 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 we always check how much of that EBIT is translated into 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 that may be a result of expenditure for growth, it does make the debt far 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. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. 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...

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.