Does Inversiones Aguas Metropolitanas (SNSE:IAM) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Inversiones Aguas Metropolitanas S.A. (SNSE:IAM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Inversiones Aguas Metropolitanas

How Much Debt Does Inversiones Aguas Metropolitanas Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Inversiones Aguas Metropolitanas had debt of CL$1.24t, up from CL$1.12t in one year. On the flip side, it has CL$164.5b in cash leading to net debt of about CL$1.08t.

A Look At Inversiones Aguas Metropolitanas' Liabilities

According to the last reported balance sheet, Inversiones Aguas Metropolitanas had liabilities of CL$253.1b due within 12 months, and liabilities of CL$1.21t due beyond 12 months. Offsetting these obligations, it had cash of CL$164.5b as well as receivables valued at CL$111.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$1.18t.

The deficiency here weighs heavily on the CL$512.5b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Inversiones Aguas Metropolitanas would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Inversiones Aguas Metropolitanas's net debt is 4.0 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 10.8 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. One way Inversiones Aguas Metropolitanas could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 17%, as it did over the last year. 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 Inversiones Aguas Metropolitanas'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 we always check how much of that EBIT is translated into free cash flow. In the last three years, Inversiones Aguas Metropolitanas's free cash flow amounted to 33% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Inversiones Aguas Metropolitanas's attempt at staying on top of its total liabilities, 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 Inversiones Aguas Metropolitanas is in the Water Utilities industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Inversiones Aguas Metropolitanas's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 3 warning signs for Inversiones Aguas Metropolitanas (1 is a bit unpleasant) you should be aware of.

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. 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.