These 4 Measures Indicate That CPFL Energia (BVMF:CPFE3) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that CPFL Energia S.A. (BVMF:CPFE3) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, 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 March 2022, CPFL Energia had R$25.4b of debt, up from R$21.9b a year ago. Click the image for more detail. On the flip side, it has R$4.08b in cash leading to net debt of about R$21.3b.

A Look At CPFL Energia's Liabilities

The latest balance sheet data shows that CPFL Energia had liabilities of R$13.0b due within a year, and liabilities of R$35.9b falling due after that. On the other hand, it had cash of R$4.08b and R$8.84b worth of receivables due within a year. So its liabilities total R$35.9b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of R$35.3b, we think shareholders really should watch CPFL Energia's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

CPFL Energia's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its commanding EBIT of 21.3 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, CPFL Energia grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, CPFL Energia's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

CPFL Energia's interest cover was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. We would also note that Electric Utilities industry companies like CPFL Energia commonly do use debt without problems. Looking at all this data makes us feel a little cautious about CPFL Energia's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for CPFL Energia that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.