Equatorial Pará Distribuidora de Energia (BVMF:EQPA3) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Equatorial Pará Distribuidora de Energia S.A. (BVMF:EQPA3) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Equatorial Pará Distribuidora de Energia

How Much Debt Does Equatorial Pará Distribuidora de Energia Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Equatorial Pará Distribuidora de Energia had debt of R$5.89b, up from R$5.32b in one year. On the flip side, it has R$3.12b in cash leading to net debt of about R$2.77b.

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

The latest balance sheet data shows that Equatorial Pará Distribuidora de Energia had liabilities of R$4.48b due within a year, and liabilities of R$7.78b falling due after that. On the other hand, it had cash of R$3.12b and R$3.23b worth of receivables due within a year. So its liabilities total R$5.91b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Equatorial Pará Distribuidora de Energia has a market capitalization of R$12.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Equatorial Pará Distribuidora de Energia's net debt is only 0.84 times its EBITDA. And its EBIT covers its interest expense a whopping 18.7 times over. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Equatorial Pará Distribuidora de Energia saw its EBIT decline by 2.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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, 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. Over the last three years, Equatorial Pará Distribuidora de Energia recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Equatorial Pará Distribuidora de Energia's ability to convert EBIT to free cash flow nor its EBIT growth rate gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. We should also note that Electric Utilities industry companies like Equatorial Pará Distribuidora de Energia commonly do use debt without problems. We think that Equatorial Pará Distribuidora de Energia'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 instance, we've identified 3 warning signs for Equatorial Pará Distribuidora de Energia (1 is a bit unpleasant) you should be aware of.

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.