Is Transmissora Aliança de Energia Elétrica (BVMF:TAEE11) A Risky Investment?

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. We note that Transmissora Aliança de Energia Elétrica S.A. (BVMF:TAEE11) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Transmissora Aliança de Energia Elétrica

What Is Transmissora Aliança de Energia Elétrica's Net Debt?

The chart below, which you can click on for greater detail, shows that Transmissora Aliança de Energia Elétrica had R$10.1b in debt in September 2024; about the same as the year before. On the flip side, it has R$1.03b in cash leading to net debt of about R$9.09b.

How Strong Is Transmissora Aliança de Energia Elétrica's Balance Sheet?

We can see from the most recent balance sheet that Transmissora Aliança de Energia Elétrica had liabilities of R$2.21b falling due within a year, and liabilities of R$11.0b due beyond that. Offsetting these obligations, it had cash of R$1.03b as well as receivables valued at R$1.77b due within 12 months. So it has liabilities totalling R$10.4b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of R$11.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Transmissora Aliança de Energia Elétrica has a debt to EBITDA ratio of 4.1 and its EBIT covered its interest expense 3.3 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Transmissora Aliança de Energia Elétrica grew its EBIT a smooth 42% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Transmissora Aliança de Energia Elétrica'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. During the last three years, Transmissora Aliança de Energia Elétrica produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

When it comes to the balance sheet, the standout positive for Transmissora Aliança de Energia Elétrica was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its net debt to EBITDA makes us a little nervous about its debt. We would also note that Electric Utilities industry companies like Transmissora Aliança de Energia Elétrica commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Transmissora Aliança de Energia Elétrica's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Transmissora Aliança de Energia Elétrica (at least 1 which is concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.