Here's Why Empresas CMPC (SNSE:CMPC) Can Manage Its Debt Responsibly

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, Empresas CMPC S.A. (SNSE:CMPC) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Empresas CMPC

How Much Debt Does Empresas CMPC Carry?

As you can see below, at the end of March 2022, Empresas CMPC had US$4.40b of debt, up from US$3.98b a year ago. Click the image for more detail. However, because it has a cash reserve of US$1.32b, its net debt is less, at about US$3.08b.

A Look At Empresas CMPC's Liabilities

We can see from the most recent balance sheet that Empresas CMPC had liabilities of US$2.08b falling due within a year, and liabilities of US$5.62b due beyond that. Offsetting these obligations, it had cash of US$1.32b as well as receivables valued at US$1.43b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.95b.

Given this deficit is actually higher than the company's market capitalization of US$3.80b, we think shareholders really should watch Empresas CMPC's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Empresas CMPC's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 4.9 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Empresas CMPC's EBIT launched higher than Elon Musk, gaining a whopping 296% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Empresas CMPC's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Empresas CMPC 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

Both Empresas CMPC's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. Looking at all this data makes us feel a little cautious about Empresas CMPC's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Empresas CMPC has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.