We Think Aguas Andinas (SNSE:AGUAS-A) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Aguas Andinas S.A. (SNSE:AGUAS-A) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Aguas Andinas

How Much Debt Does Aguas Andinas Carry?

As you can see below, Aguas Andinas had CL$1.33t of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CL$74.9b in cash offsetting this, leading to net debt of about CL$1.25t.

How Healthy Is Aguas Andinas' Balance Sheet?

We can see from the most recent balance sheet that Aguas Andinas had liabilities of CL$249.9b falling due within a year, and liabilities of CL$1.32t due beyond that. Offsetting this, it had CL$74.9b in cash and CL$123.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$1.38t.

This deficit is considerable relative to its market capitalization of CL$1.92t, so it does suggest shareholders should keep an eye on Aguas Andinas' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 4.0 times its EBITDA, and its EBIT cover its interest expense 6.2 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Aguas Andinas grew its EBIT by 3.6% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Aguas Andinas recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Aguas Andinas's net debt to EBITDA and its level of total liabilities were discouraging. At least its interest cover gives us reason to be optimistic. We should also note that Water Utilities industry companies like Aguas Andinas commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Aguas Andinas is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Aguas Andinas that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.