We Think Equatorial Pará Distribuidora de Energia (BVMF:EQPA3) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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.

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When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

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

As you can see below, at the end of June 2025, Equatorial Pará Distribuidora de Energia had R$6.81b of debt, up from R$5.01b a year ago. Click the image for more detail. However, because it has a cash reserve of R$2.10b, its net debt is less, at about R$4.71b.

How Strong 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$5.80b falling due within a year, and liabilities of R$7.47b due beyond that. Offsetting this, it had R$2.10b in cash and R$3.46b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$7.70b.

This deficit is considerable relative to its market capitalization of R$12.0b, so it does suggest shareholders should keep an eye on Equatorial Pará Distribuidora de Energia's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

See our latest analysis for Equatorial Pará Distribuidora de Energia

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Equatorial Pará Distribuidora de Energia's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its strong interest cover of 14.9 times, makes us even more comfortable. On the other hand, Equatorial Pará Distribuidora de Energia's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Equatorial Pará Distribuidora de Energia will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Equatorial Pará Distribuidora de Energia actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Equatorial Pará Distribuidora de Energia's EBIT growth rate left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We should also note that Electric Utilities industry companies like Equatorial Pará Distribuidora de Energia commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that Equatorial Pará Distribuidora de Energia's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 3 warning signs for Equatorial Pará Distribuidora de Energia (2 can't be ignored!) that you should be aware of before investing here.

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.