Is Transmissora Aliança de Energia Elétrica (BVMF:TAEE11) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Transmissora Aliança de Energia Elétrica S.A. (BVMF:TAEE11) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Transmissora Aliança de Energia Elétrica

How Much Debt Does Transmissora Aliança de Energia Elétrica Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Transmissora Aliança de Energia Elétrica had debt of R$6.46b, up from R$5.89b in one year. However, because it has a cash reserve of R$1.02b, its net debt is less, at about R$5.44b.

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

The latest balance sheet data shows that Transmissora Aliança de Energia Elétrica had liabilities of R$895.1m due within a year, and liabilities of R$7.53b falling due after that. Offsetting this, it had R$1.02b in cash and R$1.47b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$5.93b.

While this might seem like a lot, it is not so bad since Transmissora Aliança de Energia Elétrica has a market capitalization of R$13.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Transmissora Aliança de Energia Elétrica's net debt of 2.1 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.4 times interest expense) certainly does not do anything to dispel this impression. It is well worth noting that Transmissora Aliança de Energia Elétrica's EBIT shot up like bamboo after rain, gaining 94% in the last twelve months. That'll make it easier to manage its 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Transmissora Aliança de Energia Elétrica recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Transmissora Aliança de Energia Elétrica's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. It's also worth noting that Transmissora Aliança de Energia Elétrica is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at all the aforementioned factors together, it strikes us that Transmissora Aliança de Energia Elétrica can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Transmissora Aliança de Energia Elétrica has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

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. 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.
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