These 4 Measures Indicate That Equatorial Pará Distribuidora de Energia (BVMF:EQPA3) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Equatorial Pará Distribuidora de Energia S.A. (BVMF:EQPA3) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out 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 Equatorial Pará Distribuidora de Energia had debt of R$4.23b at the end of September 2022, a reduction from R$4.70b over a year. On the flip side, it has R$1.93b in cash leading to net debt of about R$2.30b.

A Look At Equatorial Pará Distribuidora de Energia's Liabilities

According to the last reported balance sheet, Equatorial Pará Distribuidora de Energia had liabilities of R$3.01b due within 12 months, and liabilities of R$5.35b due beyond 12 months. Offsetting these obligations, it had cash of R$1.93b as well as receivables valued at R$2.51b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$3.91b.

This deficit isn't so bad because Equatorial Pará Distribuidora de Energia is worth R$13.4b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Equatorial Pará Distribuidora de Energia's low debt to EBITDA ratio of 0.88 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.4 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Also positive, Equatorial Pará Distribuidora de Energia grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Equatorial Pará Distribuidora de Energia'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Equatorial Pará Distribuidora de Energia's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Equatorial Pará Distribuidora de Energia's EBIT growth rate 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 Electric Utilities industry companies like Equatorial Pará Distribuidora de Energia commonly do use debt without problems. All these things considered, it appears that Equatorial Pará Distribuidora de Energia can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Equatorial Pará Distribuidora de Energia that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.