These 4 Measures Indicate That Companhia Energética do Rio Grande do Norte - COSERN (BVMF:CSRN3) Is Using Debt Extensively

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 Energética do Rio Grande do Norte - COSERN (BVMF:CSRN3) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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 Energética do Rio Grande do Norte - COSERN

How Much Debt Does Companhia Energética do Rio Grande do Norte - COSERN Carry?

As you can see below, Companhia Energética do Rio Grande do Norte - COSERN had R$1.71b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had R$234.0m in cash, and so its net debt is R$1.47b.

A Look At Companhia Energética do Rio Grande do Norte - COSERN's Liabilities

According to the last reported balance sheet, Companhia Energética do Rio Grande do Norte - COSERN had liabilities of R$666.0m due within 12 months, and liabilities of R$2.62b due beyond 12 months. Offsetting these obligations, it had cash of R$234.0m as well as receivables valued at R$748.0m due within 12 months. So it has liabilities totalling R$2.31b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of R$2.77b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Companhia Energética do Rio Grande do Norte - COSERN has net debt to EBITDA of 2.5 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.8 times its interest expense, and its net debt to EBITDA, was quite high, at 2.5. If Companhia Energética do Rio Grande do Norte - COSERN can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is Companhia Energética do Rio Grande do Norte - COSERN's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Companhia Energética do Rio Grande do Norte - COSERN created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Neither Companhia Energética do Rio Grande do Norte - COSERN's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. It's also worth noting that Companhia Energética do Rio Grande do Norte - COSERN is in the Electric Utilities industry, which is often considered to be quite defensive. We think that Companhia Energética do Rio Grande do Norte - COSERN's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Companhia Energética do Rio Grande do Norte - COSERN has 2 warning signs we think you should be aware of.

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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