Here's Why CPFL Energia (BVMF:CPFE3) 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.' 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. As with many other companies CPFL Energia S.A. (BVMF:CPFE3) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CPFL Energia

What Is CPFL Energia's Net Debt?

As you can see below, at the end of September 2024, CPFL Energia had R$31.2b of debt, up from R$28.7b a year ago. Click the image for more detail. However, because it has a cash reserve of R$3.82b, its net debt is less, at about R$27.3b.

A Look At CPFL Energia's Liabilities

The latest balance sheet data shows that CPFL Energia had liabilities of R$15.1b due within a year, and liabilities of R$39.0b falling due after that. Offsetting these obligations, it had cash of R$3.82b as well as receivables valued at R$9.90b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$40.4b.

When you consider that this deficiency exceeds the company's R$37.6b market capitalization, you might well be inclined to review the balance sheet intently. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 2.1, CPFL Energia uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.6 times its interest expenses harmonizes with that theme. Sadly, CPFL Energia's EBIT actually dropped 5.7% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CPFL Energia can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. In the last three years, CPFL Energia's free cash flow amounted to 33% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over CPFL Energia's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Electric Utilities industry companies like CPFL Energia 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 CPFL Energia 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 learn about the 3 warning signs we've spotted with CPFL Energia (including 1 which is concerning) .

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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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.