We Think CPFL Energia (BVMF:CPFE3) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. 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?

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What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does CPFL Energia Carry?

As you can see below, CPFL Energia had R$31.1b of debt, at March 2025, which is about the same as the year before. You can click the chart for greater detail. However, it also had R$4.05b in cash, and so its net debt is R$27.0b.

How Healthy Is CPFL Energia's Balance Sheet?

We can see from the most recent balance sheet that CPFL Energia had liabilities of R$17.6b falling due within a year, and liabilities of R$37.8b due beyond that. Offsetting these obligations, it had cash of R$4.05b as well as receivables valued at R$9.76b due within 12 months. So its liabilities total R$41.5b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of R$47.1b, so it does suggest shareholders should keep an eye on CPFL Energia's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

See our latest analysis for CPFL Energia

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.

CPFL Energia's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 6.3 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Sadly, CPFL Energia's EBIT actually dropped 2.7% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CPFL Energia's ability to maintain a healthy balance sheet going forward. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, CPFL Energia recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

CPFL Energia's struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. It's also worth noting that CPFL Energia is in the Electric Utilities industry, which is often considered to be quite defensive. When we consider all the factors discussed, it seems to us that CPFL Energia is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for CPFL Energia you should know about.

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.