Is AS Tallinna Vesi (TAL:TVEAT) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, AS Tallinna Vesi (TAL:TVEAT) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 AS Tallinna Vesi

What Is AS Tallinna Vesi's Net Debt?

The image below, which you can click on for greater detail, shows that AS Tallinna Vesi had debt of €87.6m at the end of December 2020, a reduction from €91.4m over a year. However, it also had €44.5m in cash, and so its net debt is €43.1m.

How Strong Is AS Tallinna Vesi's Balance Sheet?

We can see from the most recent balance sheet that AS Tallinna Vesi had liabilities of €13.6m falling due within a year, and liabilities of €129.9m due beyond that. On the other hand, it had cash of €44.5m and €7.02m worth of receivables due within a year. So it has liabilities totalling €91.9m more than its cash and near-term receivables, combined.

This deficit isn't so bad because AS Tallinna Vesi is worth €282.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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). 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).

AS Tallinna Vesi's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 49.3 times its interest expense, implies the debt load is as light as a peacock feather. In fact AS Tallinna Vesi's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AS Tallinna Vesi can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, AS Tallinna Vesi produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Based on what we've seen AS Tallinna Vesi is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. We would also note that Water Utilities industry companies like AS Tallinna Vesi commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that AS Tallinna Vesi is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for AS Tallinna Vesi you should know about.

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. 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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