Enel Américas (SNSE:ENELAM) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Enel Américas S.A. (SNSE:ENELAM) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Enel Américas

How Much Debt Does Enel Américas Carry?

You can click the graphic below for the historical numbers, but it shows that Enel Américas had US$6.02b of debt in September 2020, down from US$6.33b, one year before. However, it also had US$1.78b in cash, and so its net debt is US$4.25b.

How Healthy Is Enel Américas's Balance Sheet?

We can see from the most recent balance sheet that Enel Américas had liabilities of US$6.59b falling due within a year, and liabilities of US$8.37b due beyond that. Offsetting this, it had US$1.78b in cash and US$2.99b in receivables that were due within 12 months. So its liabilities total US$10.2b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of US$12.6b, so it does suggest shareholders should keep an eye on Enel Américas's use of debt. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Enel Américas's net debt is only 1.5 times its EBITDA. And its EBIT easily covers its interest expense, being 15.4 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Enel Américas's EBIT dived 20%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Enel Américas can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Looking at the most recent three years, Enel Américas recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Enel Américas's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that Enel Américas is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Enel Américas stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 Enel Américas that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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