These 4 Measures Indicate That Aguas Andinas (SNSE:AGUAS-A) Is Using Debt Extensively

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 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. Importantly, Aguas Andinas S.A. (SNSE:AGUAS-A) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Aguas Andinas

What Is Aguas Andinas's Debt?

The chart below, which you can click on for greater detail, shows that Aguas Andinas had CL$1.29t in debt in March 2024; about the same as the year before. On the flip side, it has CL$93.4b in cash leading to net debt of about CL$1.19t.

How Strong Is Aguas Andinas' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Aguas Andinas had liabilities of CL$313.3b due within 12 months and liabilities of CL$1.17t due beyond that. On the other hand, it had cash of CL$93.4b and CL$144.9b worth of receivables due within a year. So it has liabilities totalling CL$1.25t more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CL$1.59t. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Aguas Andinas's debt is 3.7 times its EBITDA, and its EBIT cover its interest expense 6.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We saw Aguas Andinas grow its EBIT by 6.3% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Aguas Andinas recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Aguas Andinas's net debt to EBITDA and its level of total liabilities were discouraging. But its not so bad at covering its interest expense with its EBIT. It's also worth noting that Aguas Andinas is in the Water Utilities industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Aguas Andinas's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Aguas Andinas that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.