Here's Why Companhiade Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) Has A Meaningful Debt Burden

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.' 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. As with many other companies Companhiade Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

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

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

The image below, which you can click on for greater detail, shows that at September 2020 Companhiade Eletricidade do Estado da Bahia - COELBA had debt of R$8.35b, up from R$7.49b in one year. However, it does have R$855.0m in cash offsetting this, leading to net debt of about R$7.49b.

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

The latest balance sheet data shows that Companhiade Eletricidade do Estado da Bahia - COELBA had liabilities of R$3.84b due within a year, and liabilities of R$11.1b falling due after that. On the other hand, it had cash of R$855.0m and R$2.91b worth of receivables due within a year. So it has liabilities totalling R$11.2b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's R$10.3b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

Companhiade Eletricidade do Estado da Bahia - COELBA's net debt is 3.4 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 11.4 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Companhiade Eletricidade do Estado da Bahia - COELBA grew its EBIT by 7.1% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Companhiade 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, 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. Over the last three years, Companhiade 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

Mulling over Companhiade Eletricidade do Estado da Bahia - COELBA's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We should also note that Electric Utilities industry companies like Companhiade Eletricidade do Estado da Bahia - COELBA commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Companhiade Eletricidade do Estado da Bahia - COELBA stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Companhiade Eletricidade do Estado da Bahia - COELBA .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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