These 4 Measures Indicate That Inversiones Aguas Metropolitanas (SNSE:IAM) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Inversiones Aguas Metropolitanas

How Much Debt Does Inversiones Aguas Metropolitanas Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Inversiones Aguas Metropolitanas had CL$1.16t of debt, an increase on CL$1.08t, over one year. However, because it has a cash reserve of CL$164.6b, its net debt is less, at about CL$993.8b.

How Healthy Is Inversiones Aguas Metropolitanas' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Inversiones Aguas Metropolitanas had liabilities of CL$249.1b due within 12 months and liabilities of CL$1.14t due beyond that. On the other hand, it had cash of CL$164.6b and CL$102.5b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$1.12t.

This deficit casts a shadow over the CL$350.1b company, like a colossus towering over mere mortals. 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 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Inversiones Aguas Metropolitanas has net debt to EBITDA of 3.9 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.0 times its interest expense, and its net debt to EBITDA, was quite high, at 3.9. One way Inversiones Aguas Metropolitanas could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 15%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

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. In the last three years, Inversiones Aguas Metropolitanas's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Inversiones Aguas Metropolitanas's level of total liabilities was disappointing. But on the bright side, its EBIT growth rate 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. Once we consider all the factors above, together, it seems to us that Inversiones Aguas Metropolitanas's debt is making it 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Inversiones Aguas Metropolitanas (2 are concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.