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Oct 31, 2023

Here's Why Light (BVMF:LIGT3) Is Weighed Down By Its Debt Load

Stock Analysis Legendary fund manager Li Lu (who Charlie Munger backed) once

Stock Analysis

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.' 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. As with many other companies Light S.A. (BVMF:LIGT3) makes use of debt. But should shareholders be worried about its use of debt?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Light

As you can see below, Light had R$11.0b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has R$1.62b in cash leading to net debt of about R$9.34b.

We can see from the most recent balance sheet that Light had liabilities of R$4.66b falling due within a year, and liabilities of R$16.2b due beyond that. Offsetting these obligations, it had cash of R$1.62b as well as receivables valued at R$2.11b due within 12 months. So its liabilities total R$17.1b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$2.02b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Light would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.37 times and a disturbingly high net debt to EBITDA ratio of 9.8 hit our confidence in Light like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Light's EBIT was down 86% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Light 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Light burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

To be frank both Light's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. It's also worth noting that Light is in the Electric Utilities industry, which is often considered to be quite defensive. Considering everything we've mentioned above, it's fair to say that Light is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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. To that end, you should be aware of the 2 warning signs we've spotted with Light .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Find out whether Light is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.

Light S.A., together with its subsidiaries, engages in the generation, transmission, distribution, and sale of electric power in Brazil.

Undervalued with reasonable growth potential.