Is Multiplan Empreendimentos Imobiliários (BVMF:MULT3) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Multiplan Empreendimentos Imobiliários S.A. (BVMF:MULT3) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Multiplan Empreendimentos Imobiliários

What Is Multiplan Empreendimentos Imobiliários's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Multiplan Empreendimentos Imobiliários had debt of R$3.53b, up from R$3.12b in one year. On the flip side, it has R$950.7m in cash leading to net debt of about R$2.58b.

How Strong Is Multiplan Empreendimentos Imobiliários's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Multiplan Empreendimentos Imobiliários had liabilities of R$942.6m due within 12 months and liabilities of R$3.70b due beyond that. Offsetting these obligations, it had cash of R$950.7m as well as receivables valued at R$435.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$3.3b.

Multiplan Empreendimentos Imobiliários has a market capitalization of R$12.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Multiplan Empreendimentos Imobiliários has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 6.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One way Multiplan Empreendimentos Imobiliários could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Multiplan Empreendimentos Imobiliários's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Multiplan Empreendimentos Imobiliários actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Multiplan Empreendimentos Imobiliários's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Taking all this data into account, it seems to us that Multiplan Empreendimentos Imobiliários takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Multiplan Empreendimentos Imobiliários , and understanding them should be part of your investment process.

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.

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