We Think Transmissora Aliança de Energia Elétrica (BVMF:TAEE11) Can Stay On Top Of Its 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Transmissora Aliança de Energia Elétrica S.A. (BVMF:TAEE11) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Transmissora Aliança de Energia Elétrica

What Is Transmissora Aliança de Energia Elétrica's Debt?

The chart below, which you can click on for greater detail, shows that Transmissora Aliança de Energia Elétrica had R$6.80b in debt in June 2021; about the same as the year before. However, it also had R$719.5m in cash, and so its net debt is R$6.09b.

A Look At Transmissora Aliança de Energia Elétrica's Liabilities

Zooming in on the latest balance sheet data, we can see that Transmissora Aliança de Energia Elétrica had liabilities of R$1.12b due within 12 months and liabilities of R$7.69b due beyond that. Offsetting these obligations, it had cash of R$719.5m as well as receivables valued at R$1.40b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$6.69b.

Transmissora Aliança de Energia Elétrica has a market capitalization of R$12.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Transmissora Aliança de Energia Elétrica's net debt of 2.1 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 8.6 times its interest expenses harmonizes with that theme. Importantly, Transmissora Aliança de Energia Elétrica grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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'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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Transmissora Aliança de Energia Elétrica's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Transmissora Aliança de Energia Elétrica's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. We would also note that Electric Utilities industry companies like Transmissora Aliança de Energia Elétrica commonly do use debt without problems. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Transmissora Aliança de Energia Elétrica has 3 warning signs (and 2 which can't be ignored) 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.
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