Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Quiñenco S.A. (SNSE:QUINENCO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
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What Is Quiñenco's Net Debt?
As you can see below, at the end of September 2022, Quiñenco had CL$18t of debt, up from CL$17t a year ago. Click the image for more detail. However, it does have CL$718.7b in cash offsetting this, leading to net debt of about CL$18t.
A Look At Quiñenco's Liabilities
We can see from the most recent balance sheet that Quiñenco had liabilities of CL$38t falling due within a year, and liabilities of CL$17t due beyond that. Offsetting this, it had CL$718.7b in cash and CL$888.4b in receivables that were due within 12 months. So its liabilities total CL$54t more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CL$4.56t company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Quiñenco would likely require a major re-capitalisation if it had to pay its creditors today.
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 Quiñenco has a sky high EBITDA ratio of 9.3, implying high debt, but a strong interest coverage of 26.3. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, Quiñenco grew its EBIT by 91% 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 it is Quiñenco'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Quiñenco actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
While Quiñenco's level of total liabilities has us nervous. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Quiñenco is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 2 warning signs for Quiñenco (1 doesn't sit too well with us!) that you should be aware of before investing here.
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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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.
About SNSE:QUINENCO
Quiñenco
A business conglomerate, operates in the industrial and financial services sectors in Chile and internationally.
Adequate balance sheet slight.