Empresas La Polar (SNSE:NUEVAPOLAR) Takes On Some Risk With Its Use Of 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. Importantly, Empresas La Polar S.A. (SNSE:NUEVAPOLAR) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Empresas La Polar

How Much Debt Does Empresas La Polar Carry?

The image below, which you can click on for greater detail, shows that Empresas La Polar had debt of CL$52.0b at the end of March 2021, a reduction from CL$66.7b over a year. On the flip side, it has CL$32.2b in cash leading to net debt of about CL$19.8b.

A Look At Empresas La Polar's Liabilities

We can see from the most recent balance sheet that Empresas La Polar had liabilities of CL$99.8b falling due within a year, and liabilities of CL$178.0b due beyond that. Offsetting these obligations, it had cash of CL$32.2b as well as receivables valued at CL$62.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$183.1b.

The deficiency here weighs heavily on the CL$48.3b 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. After all, Empresas La Polar 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Empresas La Polar has a very low debt to EBITDA ratio of 0.71 so it is strange to see weak interest coverage, with last year's EBIT being only 1.3 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We also note that Empresas La Polar improved its EBIT from a last year's loss to a positive CL$15b. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Empresas La Polar 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Empresas La Polar actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Empresas La Polar's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Empresas La Polar stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Case in point: We've spotted 1 warning sign for Empresas La Polar you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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