Is Light (BVMF:LIGT3) Using Too Much 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. Importantly, Light S.A. (BVMF:LIGT3) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Light

How Much Debt Does Light Carry?

As you can see below, at the end of June 2024, Light had R$12.4b of debt, up from R$11.0b a year ago. Click the image for more detail. On the flip side, it has R$2.77b in cash leading to net debt of about R$9.60b.

How Healthy Is Light's Balance Sheet?

We can see from the most recent balance sheet that Light had liabilities of R$15.0b falling due within a year, and liabilities of R$6.57b due beyond that. On the other hand, it had cash of R$2.77b and R$2.88b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$15.9b.

This deficit casts a shadow over the R$2.98b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Light would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Light has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 2.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One redeeming factor for Light is that it turned last year's EBIT loss into a gain of R$1.6b, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Light's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Light recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

We'd go so far as to say Light's level of total liabilities was disappointing. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We should also note that Electric Utilities industry companies like Light commonly do use debt without problems. Looking at the bigger picture, it seems clear to us that Light's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. To that end, you should learn about the 2 warning signs we've spotted with Light (including 1 which makes us a bit uncomfortable) .

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.