We Think Sociedad Anónima Viña Santa Rita (SNSE:SANTA RITA) Is Taking Some Risk With Its Debt

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.' 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. As with many other companies Sociedad Anónima Viña Santa Rita (SNSE:SANTA RITA) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sociedad Anónima Viña Santa Rita

What Is Sociedad Anónima Viña Santa Rita's Debt?

As you can see below, Sociedad Anónima Viña Santa Rita had CL$93.0b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had CL$14.7b in cash, and so its net debt is CL$78.4b.

A Look At Sociedad Anónima Viña Santa Rita's Liabilities

According to the last reported balance sheet, Sociedad Anónima Viña Santa Rita had liabilities of CL$52.1b due within 12 months, and liabilities of CL$81.2b due beyond 12 months. Offsetting this, it had CL$14.7b in cash and CL$56.5b in receivables that were due within 12 months. So its liabilities total CL$62.2b more than the combination of its cash and short-term receivables.

Sociedad Anónima Viña Santa Rita has a market capitalization of CL$149.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sociedad Anónima Viña Santa Rita's debt is 3.9 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Sociedad Anónima Viña Santa Rita improved its EBIT by 7.9% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sociedad Anónima Viña Santa Rita'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. In the last three years, Sociedad Anónima Viña Santa Rita created free cash flow amounting to 14% 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 conversion of EBIT to free cash flow and its net debt to EBITDA 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. While that debt can boost returns, we think the company has enough leverage now. 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. For instance, we've identified 2 warning signs for Sociedad Anónima Viña Santa Rita (1 is significant) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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