Eternit (BVMF:ETER3) Has Debt But No Earnings; Should You Worry?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Eternit S.A. (BVMF:ETER3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Eternit

What Is Eternit's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Eternit had R$96.9m of debt in June 2020, down from R$139.0m, one year before. On the flip side, it has R$34.9m in cash leading to net debt of about R$62.0m.

A Look At Eternit's Liabilities

We can see from the most recent balance sheet that Eternit had liabilities of R$231.1m falling due within a year, and liabilities of R$317.1m due beyond that. Offsetting this, it had R$34.9m in cash and R$130.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$383.3m.

This deficit casts a shadow over the R$234.0m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Eternit would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Eternit's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Eternit made a loss at the EBIT level, and saw its revenue drop to R$501m, which is a fall of 5.5%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Eternit produced an earnings before interest and tax (EBIT) loss. Indeed, it lost R$17.5m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. But on the bright side the company actually produced a statutory profit of R$40m and free cash flow of R$23m. So there is definitely a chance that it can improve things in the next few years. 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. For example, we've discovered 5 warning signs for Eternit (1 is a bit unpleasant!) that you should be aware of before investing here.

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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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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