Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) 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.' 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. Importantly, Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) does carry debt. But the real question is whether this debt is making the company risky.

Our free stock report includes 2 warning signs investors should be aware of before investing in Companhia de Saneamento Básico do Estado de São Paulo - SABESP. Read for free now.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

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

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Companhia de Saneamento Básico do Estado de São Paulo - SABESP had R$24.8b of debt, an increase on R$19.1b, over one year. On the flip side, it has R$5.38b in cash leading to net debt of about R$19.4b.

A Look At Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Liabilities

We can see from the most recent balance sheet that Companhia de Saneamento Básico do Estado de São Paulo - SABESP had liabilities of R$12.0b falling due within a year, and liabilities of R$32.1b due beyond that. On the other hand, it had cash of R$5.38b and R$4.78b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$33.9b.

This deficit isn't so bad because Companhia de Saneamento Básico do Estado de São Paulo - SABESP is worth a massive R$77.5b, 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.

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

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

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 15.8 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Companhia de Saneamento Básico do Estado de São Paulo - SABESP grew its EBIT by 146% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding 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. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Happily, Companhia de Saneamento Básico do Estado de São Paulo - SABESP's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. 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. All these things considered, it appears that Companhia de Saneamento Básico do Estado de São Paulo - SABESP can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. To that end, you should learn about the 2 warning signs we've spotted with Companhia de Saneamento Básico do Estado de São Paulo - SABESP (including 1 which shouldn't be ignored) .

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.