David Iben put it right when he said: “Volatility is not a risk that interests us. What we care about is preventing permanent loss of capital.” So it may go without saying that debt needs to be taken into account when considering how risky a particular security is, as excessive debt can cause a company to sink. Empresas Hites SA (SNSE: HITES) has debts on its balance sheet. But the real question is whether this debt makes the venture risky.
Why does debt carry risks?
Debt and other obligations become risky for a company when it is unable to meet these obligations easily, either with free cash flow or by raising capital at an attractive price. If the company is unable to meet its legal obligations to repay the debt, shareholders could end up leaving with nothing. However, a more frequent (but still expensive) event is a company having to issue shares at spot prices, permanently diluting shareholders, just to strengthen their balance sheet. The benefit of debt, of course, is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at a high return. The first thing to do when considering the amount of debt used by a company is to look at liquidity and debt together.
What is the net debt of Empresas Hites?
As you can see below, Empresas Hites had $ 95.3 billion in debt in March 2021, down from $ 139.4 billion a year earlier. On the other hand, it has CL $ 52.4 billion in cash, which leads to a net debt of around CL $ 42.9 billion.
How healthy is the Empresas Hites equilibrium?
The latest balance sheet data shows that Empresas Hites had $ 90.8 billion in debt due within one year and $ 204.1 billion in debt due later. On the other hand, it had a cash value of CL $ 52.4 billion and CL $ 86.6 billion in receivables due within one year. It therefore has liabilities totaling $ 155.9 billion in CL more than cash and short-term credit combined.
The shortfall weighs heavily on the CL $ 55.3 billion company itself, as if a child were struggling under the weight of a huge backpack filled with books, his sports gear and a trumpet. So we definitely think shareholders should keep an eye on this. After all, Empresas Hites would likely need a major recapitalization if it were to pay its creditors today.
To update a company’s debt against revenue, we calculate net debt divided by revenue before interest, tax, depreciation (EBITDA) and revenue before interest and tax (EBIT) divided by interest expense (they are coverage of interests). We then consider debt in relation to earnings, both with and without depreciation and amortization costs.
While Empresas Hites’ debt is only 2.3, the interest coverage at 1.1 is actually very low. The main reason for this is that it has such a high depreciation and amortization rate. These expenses can be non-cash, so they can be excluded when it comes to paying off the debt. But accounting costs exist for a reason: some assets seem to lose value. Either way, there is no doubt that the stock uses significant leverage. Importantly, Empresas Hites’ EBIT has fallen by up to 47% over the past twelve months. If this earnings trend continues, paying off your debt will be as easy as taking cats on a roller coaster. The budget is clearly the area to focus on when analyzing debt. But it is above all future income that will determine Empresas Hites’ ability to maintain a healthy budget in the future. So, if you are focused on the future, check this out free Analyst Earnings Forecast Report.
Finally, a company needs free cash flow to pay off debt; accounting profits just don’t. So it’s worth checking how much of that EBIT is backed up by free cash flow. Over the past three years, Empresas Hites has produced even freer cash flow than EBIT. This kind of strong cash conversion makes us just as excited as the audience when the beat sinks into a Daft Punk concert.
Our point of view
At first glance, Empresas Hites’ EBIT growth left us hesitant about inventory, and the level of total liabilities was no more attractive than that empty restaurant on the busiest night of the year. But on the upside, the conversion from EBIT to free cash flow is a good sign and makes us more optimistic. We are pretty clear that we consider Empresas Hites to be quite risky, due to its balance sheet health. For this reason we are rather cautious with the stock and believe that shareholders should keep an eye on liquidity. There is no doubt that we learn more about debt from the budget. But ultimately, any business can contain risks that exist off-balance sheet. To do this, you need to know more about the 4 warning signs we have seen with Empresas Hites (2 of which are worrying) .
If you are the type of investor who prefers to buy debt-free stocks, don’t hesitate to find out our exclusive list of net cash growth stocks, today.
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