Is Empresas Hites (SNSE:HITES) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Empresas Hites S.A. (SNSE:HITES) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Empresas Hites

What Is Empresas Hites's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Empresas Hites had CL$114.3b of debt in December 2021, down from CL$139.6b, one year before. However, because it has a cash reserve of CL$41.2b, its net debt is less, at about CL$73.1b.

How Strong Is Empresas Hites' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Empresas Hites had liabilities of CL$111.1b due within 12 months and liabilities of CL$194.0b due beyond that. Offsetting these obligations, it had cash of CL$41.2b as well as receivables valued at CL$115.9b due within 12 months. So its liabilities total CL$147.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CL$47.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Empresas Hites would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Empresas Hites has net debt of just 1.1 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.0 times the interest expense over the last year. Although Empresas Hites made a loss at the EBIT level, last year, it was also good to see that it generated CL$58b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Empresas Hites'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Empresas Hites recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

We'd go so far as to say Empresas Hites's level of total liabilities was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Empresas Hites's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 5 warning signs with Empresas Hites (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.