These 4 Measures Indicate That ISC Fresh Water Investment SOCIMI (BME:YISC) 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.' 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. Importantly, ISC Fresh Water Investment SOCIMI, S.A. (BME:YISC) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ISC Fresh Water Investment SOCIMI

How Much Debt Does ISC Fresh Water Investment SOCIMI Carry?

You can click the graphic below for the historical numbers, but it shows that ISC Fresh Water Investment SOCIMI had €172.0m of debt in December 2020, down from €185.9m, one year before. Net debt is about the same, since the it doesn't have much cash.

A Look At ISC Fresh Water Investment SOCIMI's Liabilities

According to the last reported balance sheet, ISC Fresh Water Investment SOCIMI had liabilities of €16.4m due within 12 months, and liabilities of €168.0m due beyond 12 months. Offsetting this, it had €1.99m in cash and €176.9k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €182.2m.

Given this deficit is actually higher than the company's market capitalization of €137.9m, we think shareholders really should watch ISC Fresh Water Investment SOCIMI's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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

ISC Fresh Water Investment SOCIMI has a rather high debt to EBITDA ratio of 8.0 which suggests a meaningful debt load. However, its interest coverage of 4.5 is reasonably strong, which is a good sign. ISC Fresh Water Investment SOCIMI grew its EBIT by 3.5% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since ISC Fresh Water Investment SOCIMI will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, ISC Fresh Water Investment SOCIMI actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, ISC Fresh Water Investment SOCIMI's level of total liabilities left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that ISC Fresh Water Investment SOCIMI'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. 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. For example - ISC Fresh Water Investment SOCIMI has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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