Is the Companhia de Saneamento Básico do Estado de São Paulo – SABESP (BVMF: SBSP3) using too much debt?

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Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Companhia de Saneamento Básico do Estado de São Paulo – SABESP (BVMF: SBSP3) uses debt in its business. But the most important question is: what risk does this debt create?

Why Does Debt Bring Risk?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest analysis for Companhia de Saneamento Básico do Estado de São Paulo – SABESP

What is the debt of the Companhia de Saneamento Básico do Estado de São Paulo – SABESP?

The graph below, which you can click for more details, shows that the Companhia de Saneamento Básico do Estado de São Paulo – SABESP had 16.0 billion reais in debt in June 2021; about the same as the year before. On the other hand, he has 2.95 billion reais in cash, resulting in a net debt of about 13.0 billion reais.

BOVESPA: SBSP3 History of debt to equity November 1, 2021

What is the balance sheet of the Companhia de Saneamento Básico do Estado de São Paulo – SABESP?

We can see from the most recent balance sheet that the Companhia de Saneamento Básico do Estado de São Paulo – SABESP had liabilities of 5.93 billion reais due within one year and liabilities of 21.0 billion. of reais beyond. On the other hand, he had cash of 2.95 billion reais and 2.37 billion reais in debts due within one year. It therefore has liabilities totaling R $ 21.6 billion more than its combined cash and short-term receivables.

This is a mountain of leverage compared to its market capitalization of 24.1 billion reais. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Companhia de Saneamento Básico do Estado de São Paulo – SABESP’s net debt of 2.1 times EBITDA suggests graceful use of debt. And the attractive interest coverage (EBIT of 8.4 times the interest costs) certainly does not do everything to dispel this impression. Shareholders should know that the EBIT of Companhia de Saneamento Básico do Estado de São Paulo – SABESP fell by 28% last year. If this earnings trend continues, paying off debt will be about as easy as driving cats on a roller coaster. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the future profitability of the business will decide whether the Companhia de Saneamento Básico do Estado de São Paulo – SABESP can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, the free cash flow of the Companhia de Saneamento Básico do Estado de São Paulo – SABESP has been 23% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.

Our point of view

We would go so far as to say Companhia de Saneamento Básico do Estado de São Paulo – SABESP’s EBIT growth rate has been disappointing. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. It should also be noted that the Companhia de Saneamento Básico do Estado de São Paulo – SABESP belongs to the water services sector, which is often seen as quite defensive. Overall, we think it’s fair to say that the Companhia de Saneamento Básico do Estado de São Paulo – SABESP has enough debt that there are real risks around the balance sheet. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – Companhia de Saneamento Básico do Estado de São Paulo – SABESP a 1 warning sign we think you should be aware.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.

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