These 4 Measures Indicate That Empresa Constructora Moller y Pérez Cotapos (SNSE:MOLLER) Is Using Debt In A Risky Way

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Empresa Constructora Moller y Pérez Cotapos S.A. (SNSE:MOLLER) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Empresa Constructora Moller y Pérez Cotapos

What Is Empresa Constructora Moller y Pérez Cotapos's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Empresa Constructora Moller y Pérez Cotapos had CL$242.4b of debt, an increase on CL$216.2b, over one year. However, because it has a cash reserve of CL$14.8b, its net debt is less, at about CL$227.6b.

A Look At Empresa Constructora Moller y Pérez Cotapos' Liabilities

According to the last reported balance sheet, Empresa Constructora Moller y Pérez Cotapos had liabilities of CL$259.1b due within 12 months, and liabilities of CL$87.1b due beyond 12 months. Offsetting this, it had CL$14.8b in cash and CL$75.5b in receivables that were due within 12 months. So it has liabilities totalling CL$255.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CL$118.8b 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, Empresa Constructora Moller y Pérez Cotapos would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Strangely Empresa Constructora Moller y Pérez Cotapos has a sky high EBITDA ratio of 32.4, implying high debt, but a strong interest coverage of 23.3. So either it has access to very cheap long term debt or that interest expense is going to grow! Shareholders should be aware that Empresa Constructora Moller y Pérez Cotapos's EBIT was down 46% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Empresa Constructora Moller y Pérez Cotapos's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Empresa Constructora Moller y Pérez Cotapos burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Empresa Constructora Moller y Pérez Cotapos's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Considering all the factors previously mentioned, we think that Empresa Constructora Moller y Pérez Cotapos really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Empresa Constructora Moller y Pérez Cotapos (including 1 which is a bit concerning) .

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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