Enel Distribucion Chile (SNSE:ENELDXCH) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Enel Distribucion Chile S.A. (SNSE:ENELDXCH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Enel Distribucion Chile

What Is Enel Distribucion Chile's Debt?

You can click the graphic below for the historical numbers, but it shows that Enel Distribucion Chile had CL$94.0b of debt in December 2020, down from CL$136.1b, one year before. On the flip side, it has CL$2.55b in cash leading to net debt of about CL$91.5b.

How Healthy Is Enel Distribucion Chile's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Enel Distribucion Chile had liabilities of CL$395.0b due within 12 months and liabilities of CL$355.6b due beyond that. Offsetting this, it had CL$2.55b in cash and CL$238.9b in receivables that were due within 12 months. So its liabilities total CL$509.1b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Enel Distribucion Chile has a market capitalization of CL$1.38t, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Enel Distribucion Chile's net debt is only 0.68 times its EBITDA. And its EBIT covers its interest expense a whopping 11.9 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Enel Distribucion Chile's saving grace is its low debt levels, because its EBIT has tanked 35% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Enel Distribucion Chile will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Enel Distribucion Chile reported free cash flow worth 3.7% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Enel Distribucion Chile's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its interest cover was re-invigorating. We should also note that Electric Utilities industry companies like Enel Distribucion Chile commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Enel Distribucion Chile 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. Be aware that Enel Distribucion Chile is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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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