Here's Why Sociedad Anónima Viña Santa Rita (SNSE:SANTA RITA) Has A Meaningful Debt Burden

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. Importantly, Sociedad Anónima Viña Santa Rita (SNSE:SANTA RITA) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sociedad Anónima Viña Santa Rita

How Much Debt Does Sociedad Anónima Viña Santa Rita Carry?

As you can see below, at the end of September 2020, Sociedad Anónima Viña Santa Rita had CL$121.2b of debt, up from CL$95.8b a year ago. Click the image for more detail. However, because it has a cash reserve of CL$36.9b, its net debt is less, at about CL$84.3b.

How Strong Is Sociedad Anónima Viña Santa Rita's Balance Sheet?

We can see from the most recent balance sheet that Sociedad Anónima Viña Santa Rita had liabilities of CL$80.5b falling due within a year, and liabilities of CL$85.5b due beyond that. On the other hand, it had cash of CL$36.9b and CL$61.3b worth of receivables due within a year. So it has liabilities totalling CL$67.7b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Sociedad Anónima Viña Santa Rita is worth CL$149.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Sociedad Anónima Viña Santa Rita has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 4.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We saw Sociedad Anónima Viña Santa Rita grow its EBIT by 6.4% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sociedad Anónima Viña Santa Rita will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Sociedad Anónima Viña Santa Rita created free cash flow amounting to 18% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Both Sociedad Anónima Viña Santa Rita's net debt to EBITDA and its conversion of EBIT to free cash flow were discouraging. At least its EBIT growth rate gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Sociedad Anónima Viña Santa Rita is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Sociedad Anónima Viña Santa Rita you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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