We Think Empresas Hites (SNSE:HITES) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Empresas Hites S.A. (SNSE:HITES) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Empresas Hites

What Is Empresas Hites's Debt?

The image below, which you can click on for greater detail, shows that Empresas Hites had debt of CL$124.5b at the end of June 2021, a reduction from CL$143.1b over a year. However, it does have CL$57.9b in cash offsetting this, leading to net debt of about CL$66.6b.

A Look At Empresas Hites' Liabilities

According to the last reported balance sheet, Empresas Hites had liabilities of CL$90.1b due within 12 months, and liabilities of CL$198.5b due beyond 12 months. Offsetting these obligations, it had cash of CL$57.9b as well as receivables valued at CL$84.7b due within 12 months. So it has liabilities totalling CL$145.9b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CL$51.0b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Empresas Hites would probably need a major re-capitalization if its creditors were to demand repayment.

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 worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.6 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Pleasingly, Empresas Hites is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 2,045% gain in the last twelve months. 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 Empresas Hites will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. Happily for any shareholders, Empresas Hites actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

While Empresas Hites's level of total liabilities has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Empresas Hites's debt does make it a bit risky, after considering the aforementioned data points together. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Empresas Hites (1 is a bit unpleasant!) that you should be aware of before investing here.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.