Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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.

Check out our latest analysis for Companhia de Saneamento Básico do Estado de São Paulo - SABESP

What Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Companhia de Saneamento Básico do Estado de São Paulo - SABESP had R$23.4b of debt, an increase on R$18.5b, over one year. However, because it has a cash reserve of R$3.67b, its net debt is less, at about R$19.7b.

How Strong Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Companhia de Saneamento Básico do Estado de São Paulo - SABESP had liabilities of R$7.17b due within 12 months and liabilities of R$31.1b due beyond that. On the other hand, it had cash of R$3.67b and R$3.92b worth of receivables due within a year. So it has liabilities totalling R$30.6b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Companhia de Saneamento Básico do Estado de São Paulo - SABESP is worth R$60.2b, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Companhia de Saneamento Básico do Estado de São Paulo - SABESP has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 16.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Companhia de Saneamento Básico do Estado de São Paulo - SABESP grew its EBIT by 203% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Companhia de Saneamento Básico do Estado de São Paulo - SABESP'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.

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. In the last three years, Companhia de Saneamento Básico do Estado de São Paulo - SABESP basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

Both Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. It's also worth noting that Companhia de Saneamento Básico do Estado de São Paulo - SABESP is in the Water Utilities industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that Companhia de Saneamento Básico do Estado de São Paulo - SABESP is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 Companhia de Saneamento Básico do Estado de São Paulo - SABESP has 2 warning signs (and 1 which is concerning) we think you should know about.

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.