Does Quiñenco (SNSE:QUINENCO) Have A Healthy Balance Sheet?

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.' 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 can see that Quiñenco SA (SNSE:QUINENCO) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Quiñenco

What Is Quiñenco's Net Debt?

As you can see below, at the end of September 2020, Quiñenco had CL$17t of debt, up from CL$13t a year ago. Click the image for more detail. However, it does have CL$911.3b in cash offsetting this, leading to net debt of about CL$16t.

A Look At Quiñenco's Liabilities

The latest balance sheet data shows that Quiñenco had liabilities of CL$30t due within a year, and liabilities of CL$14t falling due after that. Offsetting this, it had CL$911.3b in cash and CL$222.3b in receivables that were due within 12 months. So its liabilities total CL$43t more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CL$2.34t company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Quiñenco would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Quiñenco's net debt to EBITDA ratio is 19.3 which suggests rather high debt levels, but its interest cover of 10.0 times suggests the debt is easily serviced. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. The bad news is that Quiñenco saw its EBIT decline by 13% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is Quiñenco'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. Over the last three years, Quiñenco actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both Quiñenco's net debt to EBITDA 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 conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Quiñenco's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Quiñenco you should be aware of, and 1 of them is potentially serious.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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