Companhia de Saneamento de Minas Gerais (BVMF:CSMG3) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Companhia de Saneamento de Minas Gerais (BVMF:CSMG3) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Companhia de Saneamento de Minas Gerais

What Is Companhia de Saneamento de Minas Gerais's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Companhia de Saneamento de Minas Gerais had debt of R$4.60b, up from R$3.44b in one year. On the flip side, it has R$1.25b in cash leading to net debt of about R$3.35b.

How Strong Is Companhia de Saneamento de Minas Gerais' Balance Sheet?

The latest balance sheet data shows that Companhia de Saneamento de Minas Gerais had liabilities of R$1.71b due within a year, and liabilities of R$4.41b falling due after that. On the other hand, it had cash of R$1.25b and R$1.25b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$3.63b.

Companhia de Saneamento de Minas Gerais has a market capitalization of R$8.01b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Companhia de Saneamento de Minas Gerais's net debt is only 1.5 times its EBITDA. And its EBIT easily covers its interest expense, being 20.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Companhia de Saneamento de Minas Gerais has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Companhia de Saneamento de Minas Gerais 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 we always check how much of that EBIT is translated into free cash flow. In the last three years, Companhia de Saneamento de Minas Gerais's free cash flow amounted to 23% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Companhia de Saneamento de Minas Gerais's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. We would also note that Water Utilities industry companies like Companhia de Saneamento de Minas Gerais commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Companhia de Saneamento de Minas Gerais can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Companhia de Saneamento de Minas Gerais (1 is a bit unpleasant) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.