We Think Viñedos Emiliana (SNSE:EMILIANA) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Viñedos Emiliana S.A. (SNSE:EMILIANA) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Viñedos Emiliana

How Much Debt Does Viñedos Emiliana Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Viñedos Emiliana had CL$13.3b of debt, an increase on CL$12.7b, over one year. However, because it has a cash reserve of CL$545.6m, its net debt is less, at about CL$12.8b.

How Strong Is Viñedos Emiliana's Balance Sheet?

The latest balance sheet data shows that Viñedos Emiliana had liabilities of CL$12.5b due within a year, and liabilities of CL$10.2b falling due after that. Offsetting these obligations, it had cash of CL$545.6m as well as receivables valued at CL$7.50b due within 12 months. So it has liabilities totalling CL$14.7b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CL$18.8b, so it does suggest shareholders should keep an eye on Viñedos Emiliana's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Viñedos Emiliana has a debt to EBITDA ratio of 3.9 and its EBIT covered its interest expense 4.1 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. More concerning, Viñedos Emiliana saw its EBIT drop by 4.7% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Viñedos Emiliana'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Viñedos Emiliana burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Mulling over Viñedos Emiliana's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. And furthermore, its interest cover also fails to instill confidence. We're quite clear that we consider Viñedos Emiliana to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 5 warning signs with Viñedos Emiliana (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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. 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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