Is Envases del Pacifico (SNSE:EDELPA) Using Debt In A Risky Way?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Envases del Pacifico S.A. (SNSE:EDELPA) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Envases del Pacifico

How Much Debt Does Envases del Pacifico Carry?

As you can see below, at the end of September 2020, Envases del Pacifico had CL$9.89b of debt, up from CL$4.67b a year ago. Click the image for more detail. However, it does have CL$2.10b in cash offsetting this, leading to net debt of about CL$7.80b.

How Strong Is Envases del Pacifico's Balance Sheet?

We can see from the most recent balance sheet that Envases del Pacifico had liabilities of CL$17.0b falling due within a year, and liabilities of CL$12.1b due beyond that. Offsetting this, it had CL$2.10b in cash and CL$13.5b in receivables that were due within 12 months. So it has liabilities totalling CL$13.6b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CL$11.9b, we think shareholders really should watch Envases del Pacifico's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Envases del Pacifico'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.

In the last year Envases del Pacifico wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to CL$48b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Envases del Pacifico produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CL$2.7b. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CL$2.4b over the last twelve months. That means it's on the risky side of things. 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. We've identified 2 warning signs with Envases del Pacifico (at least 1 which is significant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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