Aguas Andinas (SNSE:AGUAS-A) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Aguas Andinas S.A. (SNSE:AGUAS-A) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Aguas Andinas

How Much Debt Does Aguas Andinas Carry?

The chart below, which you can click on for greater detail, shows that Aguas Andinas had CL$1.07t in debt in September 2020; about the same as the year before. However, it also had CL$181.7b in cash, and so its net debt is CL$887.4b.

How Strong Is Aguas Andinas' Balance Sheet?

The latest balance sheet data shows that Aguas Andinas had liabilities of CL$346.1b due within a year, and liabilities of CL$1.06t falling due after that. On the other hand, it had cash of CL$181.7b and CL$81.5b worth of receivables due within a year. So it has liabilities totalling CL$1.15t more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CL$1.39t. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Aguas Andinas has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 6.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The bad news is that Aguas Andinas saw its EBIT decline by 17% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aguas Andinas's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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 that EBIT is backed by free cash flow. In the last three years, Aguas Andinas's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Aguas Andinas's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. It's also worth noting that Aguas Andinas is in the Water Utilities industry, which is often considered to be quite defensive. Looking at the bigger picture, it seems clear to us that Aguas Andinas's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Aguas Andinas (at least 1 which shouldn't be ignored) , 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. 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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