Companhia de Saneamento de Minas Gerais (BVMF:CSMG3) Seems To Use Debt Quite Sensibly

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.' 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 de Saneamento de Minas Gerais (BVMF:CSMG3) does have debt on its balance sheet. But is this debt a concern to shareholders?

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When Is Debt A Problem?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Companhia de Saneamento de Minas Gerais Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2025 Companhia de Saneamento de Minas Gerais had R$5.99b of debt, an increase on R$4.60b, over one year. However, because it has a cash reserve of R$704.6m, its net debt is less, at about R$5.28b.

A Look At Companhia de Saneamento de Minas Gerais' Liabilities

We can see from the most recent balance sheet that Companhia de Saneamento de Minas Gerais had liabilities of R$1.98b falling due within a year, and liabilities of R$5.66b due beyond that. Offsetting this, it had R$704.6m in cash and R$1.42b in receivables that were due within 12 months. So it has liabilities totalling R$5.52b more than its cash and near-term receivables, combined.

Companhia de Saneamento de Minas Gerais has a market capitalization of R$10.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

See our latest analysis for Companhia de Saneamento de Minas Gerais

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). 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 1.8, Companhia de Saneamento de Minas Gerais uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.9 times interest expense) certainly does not do anything to dispel this impression. One way Companhia de Saneamento de Minas Gerais could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 19%, as it did over the last year. 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 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.

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 last three years, Companhia de Saneamento de Minas Gerais reported free cash flow worth 5.3% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Companhia de Saneamento de Minas Gerais's EBIT growth rate was a real positive on this analysis, as was its interest cover. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. It's also worth noting that Companhia de Saneamento de Minas Gerais is in the Water Utilities industry, which is often considered to be quite defensive. When we consider all the factors mentioned above, we do feel a bit cautious about Companhia de Saneamento de Minas Gerais's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Companhia de Saneamento de Minas Gerais (of which 1 is significant!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.