Stock Analysis

We Think Echeverría Izquierdo (SNSE:EISA) Is Taking Some Risk With Its Debt

SNSE:EISA
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Echeverría Izquierdo S.A. (SNSE:EISA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Echeverría Izquierdo

What Is Echeverría Izquierdo's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Echeverría Izquierdo had CL$150.5b of debt, an increase on CL$120.0b, over one year. However, it does have CL$39.7b in cash offsetting this, leading to net debt of about CL$110.8b.

debt-equity-history-analysis
SNSE:EISA Debt to Equity History November 6th 2021

How Strong Is Echeverría Izquierdo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Echeverría Izquierdo had liabilities of CL$233.6b due within 12 months and liabilities of CL$69.8b due beyond that. Offsetting this, it had CL$39.7b in cash and CL$63.3b in receivables that were due within 12 months. So it has liabilities totalling CL$200.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CL$71.6b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Echeverría Izquierdo would probably need a major re-capitalization if its creditors were to demand repayment.

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).

Echeverría Izquierdo's debt is 4.6 times its EBITDA, and its EBIT cover its interest expense 4.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, it should be some comfort for shareholders to recall that Echeverría Izquierdo actually grew its EBIT by a hefty 121%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But it is Echeverría Izquierdo's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Echeverría Izquierdo created free cash flow amounting to 3.1% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We'd go so far as to say Echeverría Izquierdo's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. We're quite clear that we consider Echeverría Izquierdo to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Echeverría Izquierdo (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Valuation is complex, but we're helping make it simple.

Find out whether Echeverría Izquierdo is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.