Inversiones Aguas Metropolitanas (SNSE:IAM) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Inversiones Aguas Metropolitanas

What Is Inversiones Aguas Metropolitanas's Net Debt?

The chart below, which you can click on for greater detail, shows that Inversiones Aguas Metropolitanas had CL$1.07t in debt in September 2020; about the same as the year before. However, it also had CL$183.0b in cash, and so its net debt is CL$887.6b.

A Look At Inversiones Aguas Metropolitanas' Liabilities

According to the last reported balance sheet, Inversiones Aguas Metropolitanas had liabilities of CL$347.9b due within 12 months, and liabilities of CL$1.06t due beyond 12 months. On the other hand, it had cash of CL$183.0b and CL$81.7b worth of receivables due within a year. So its liabilities total CL$1.15t more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CL$562.9b 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. After all, Inversiones Aguas Metropolitanas would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Inversiones Aguas Metropolitanas has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 6.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The bad news is that Inversiones Aguas Metropolitanas saw its EBIT decline by 17% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. 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 Inversiones Aguas Metropolitanas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Inversiones Aguas Metropolitanas's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Inversiones Aguas Metropolitanas's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Water Utilities industry companies like Inversiones Aguas Metropolitanas commonly do use debt without problems. Overall, it seems to us that Inversiones Aguas Metropolitanas's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Inversiones Aguas Metropolitanas you should be aware of.

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. 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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