Does Companhia Distribuidora de Gás do Rio de Janeiro - CEG (BVMF:CEGR3) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Companhia Distribuidora de Gás do Rio de Janeiro - CEG (BVMF:CEGR3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

See our latest analysis for Companhia Distribuidora de Gás do Rio de Janeiro - CEG

How Much Debt Does Companhia Distribuidora de Gás do Rio de Janeiro - CEG Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Companhia Distribuidora de Gás do Rio de Janeiro - CEG had R$1.17b of debt, an increase on R$751.6m, over one year. However, it also had R$400.3m in cash, and so its net debt is R$773.3m.

A Look At Companhia Distribuidora de Gás do Rio de Janeiro - CEG's Liabilities

According to the last reported balance sheet, Companhia Distribuidora de Gás do Rio de Janeiro - CEG had liabilities of R$1.09b due within 12 months, and liabilities of R$1.22b due beyond 12 months. Offsetting this, it had R$400.3m in cash and R$479.3m in receivables that were due within 12 months. So it has liabilities totalling R$1.44b more than its cash and near-term receivables, combined.

Since publicly traded Companhia Distribuidora de Gás do Rio de Janeiro - CEG shares are worth a total of R$15.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Companhia Distribuidora de Gás do Rio de Janeiro - CEG has a low net debt to EBITDA ratio of only 1.0. And its EBIT covers its interest expense a whopping 16.1 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Companhia Distribuidora de Gás do Rio de Janeiro - CEG has boosted its EBIT by 64%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Companhia Distribuidora de Gás do Rio de Janeiro - CEG'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Companhia Distribuidora de Gás do Rio de Janeiro - CEG recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Companhia Distribuidora de Gás do Rio de Janeiro - CEG's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! We would also note that Gas Utilities industry companies like Companhia Distribuidora de Gás do Rio de Janeiro - CEG commonly do use debt without problems. Zooming out, Companhia Distribuidora de Gás do Rio de Janeiro - CEG seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. For example, we've discovered 1 warning sign for Companhia Distribuidora de Gás do Rio de Janeiro - CEG that you should be aware of before investing here.

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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