Here's Why Inversiones Aguas Metropolitanas (SNSE:IAM) Has A Meaningful Debt Burden

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, Inversiones Aguas Metropolitanas S.A. (SNSE:IAM) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Inversiones Aguas Metropolitanas

What Is Inversiones Aguas Metropolitanas's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Inversiones Aguas Metropolitanas had debt of CL$1.30t, up from CL$1.20t in one year. However, it also had CL$167.2b in cash, and so its net debt is CL$1.13t.

How Healthy Is Inversiones Aguas Metropolitanas' Balance Sheet?

We can see from the most recent balance sheet that Inversiones Aguas Metropolitanas had liabilities of CL$291.3b falling due within a year, and liabilities of CL$1.23t due beyond that. Offsetting these obligations, it had cash of CL$167.2b as well as receivables valued at CL$113.9b due within 12 months. So it has liabilities totalling CL$1.24t more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CL$730.7b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Inversiones Aguas Metropolitanas would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Inversiones Aguas Metropolitanas has a debt to EBITDA ratio of 3.8, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 13.2 is very high, suggesting that the interest expense on the debt is currently quite low. If Inversiones Aguas Metropolitanas can keep growing EBIT at last year's rate of 16% over the last year, then it will find its debt load easier to manage. 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 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Inversiones Aguas Metropolitanas recorded free cash flow of 31% of its EBIT, which is weaker 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. We should also note that Water Utilities industry companies like Inversiones Aguas Metropolitanas commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Inversiones Aguas Metropolitanas stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 2 warning signs with Inversiones Aguas Metropolitanas (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.