Does Equatorial Pará Distribuidora de Energia (BVMF:EQPA3) Have A Healthy Balance Sheet?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Equatorial Pará Distribuidora de Energia S.A. (BVMF:EQPA3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Equatorial Pará Distribuidora de Energia

What Is Equatorial Pará Distribuidora de Energia's Net Debt?

As you can see below, at the end of June 2023, Equatorial Pará Distribuidora de Energia had R$5.28b of debt, up from R$4.84b a year ago. Click the image for more detail. However, it also had R$1.37b in cash, and so its net debt is R$3.91b.

How Healthy Is Equatorial Pará Distribuidora de Energia's Balance Sheet?

We can see from the most recent balance sheet that Equatorial Pará Distribuidora de Energia had liabilities of R$2.82b falling due within a year, and liabilities of R$6.52b due beyond that. On the other hand, it had cash of R$1.37b and R$2.91b worth of receivables due within a year. So it has liabilities totalling R$5.07b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Equatorial Pará Distribuidora de Energia is worth R$13.9b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Equatorial Pará Distribuidora de Energia's net debt is only 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 16.9 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Equatorial Pará Distribuidora de Energia grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Equatorial Pará Distribuidora de Energia will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Equatorial Pará Distribuidora de Energia reported free cash flow worth 6.4% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On our analysis Equatorial Pará Distribuidora de Energia's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. We would also note that Electric Utilities industry companies like Equatorial Pará Distribuidora de Energia commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Equatorial Pará Distribuidora de Energia is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 example Equatorial Pará Distribuidora de Energia has 3 warning signs (and 2 which make us uncomfortable) we think 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.