Transmissora Aliança de Energia Elétrica (BVMF:TAEE11) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Transmissora Aliança de Energia Elétrica S.A. (BVMF:TAEE11) does use debt in its business. But the real question is whether this debt is making the company risky.

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

See our latest analysis for Transmissora Aliança de Energia Elétrica

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

As you can see below, at the end of December 2020, Transmissora Aliança de Energia Elétrica had R$6.27b of debt, up from R$5.31b a year ago. Click the image for more detail. On the flip side, it has R$896.0m in cash leading to net debt of about R$5.37b.

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$841.6m due within a year, and liabilities of R$7.24b falling due after that. Offsetting this, it had R$896.0m in cash and R$1.35b in receivables that were due within 12 months. So it has liabilities totalling R$5.84b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Transmissora Aliança de Energia Elétrica has a market capitalization of R$11.1b, 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 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.

With a debt to EBITDA ratio of 2.3, Transmissora Aliança de Energia Elétrica uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.2 times its interest expenses harmonizes with that theme. Notably, Transmissora Aliança de Energia Elétrica's EBIT launched higher than Elon Musk, gaining a whopping 108% on last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Transmissora Aliança de Energia Elétrica can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Transmissora Aliança de Energia Elétrica produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Transmissora Aliança de Energia Elétrica's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. We would also note that Electric Utilities industry companies like Transmissora Aliança de Energia Elétrica commonly do use debt without problems. All these things considered, it appears that Transmissora Aliança de Energia Elétrica can comfortably handle its current debt levels. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Transmissora Aliança de Energia Elétrica (of which 2 are potentially serious!) 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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