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, Cristalerías de Chile S.A. (SNSE:CRISTALES) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.
What Is Cristalerías de Chile’s Debt?
As you can see below, at the end of September 2019, Cristalerías de Chile had CL$165.8b of debt, up from CL$120.7k a year ago. Click the image for more detail. On the flip side, it has CL$26.4b in cash leading to net debt of about CL$139.5b.
A Look At Cristalerías de Chile’s Liabilities
We can see from the most recent balance sheet that Cristalerías de Chile had liabilities of CL$91.0b falling due within a year, and liabilities of CL$183.0b due beyond that. Offsetting these obligations, it had cash of CL$26.4b as well as receivables valued at CL$106.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$141.5b.
While this might seem like a lot, it is not so bad since Cristalerías de Chile has a market capitalization of CL$338.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Cristalerías de Chile’s net debt of 2.3 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 10.0 times interest expense) certainly does not do anything to dispel this impression. One way Cristalerías de Chile could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. 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 Cristalerías de Chile 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Cristalerías de Chile burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Cristalerías de Chile’s struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its interest cover was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Cristalerías de Chile 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. Be aware that Cristalerías de Chile is showing 2 warning signs in our investment analysis , 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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