These 4 Measures Indicate That BrasilAgro - Companhia Brasileira de Propriedades Agrícolas (BVMF:AGRO3) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that BrasilAgro - Companhia Brasileira de Propriedades Agrícolas (BVMF:AGRO3) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for BrasilAgro - Companhia Brasileira de Propriedades Agrícolas

What Is BrasilAgro - Companhia Brasileira de Propriedades Agrícolas's Net Debt?

As you can see below, at the end of March 2020, BrasilAgro - Companhia Brasileira de Propriedades Agrícolas had R$443.3m of debt, up from R$273.7m a year ago. Click the image for more detail. On the flip side, it has R$79.7m in cash leading to net debt of about R$363.5m.

How Healthy Is BrasilAgro - Companhia Brasileira de Propriedades Agrícolas's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BrasilAgro - Companhia Brasileira de Propriedades Agrícolas had liabilities of R$283.6m due within 12 months and liabilities of R$546.5m due beyond that. Offsetting this, it had R$79.7m in cash and R$145.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$604.8m.

BrasilAgro - Companhia Brasileira de Propriedades Agrícolas has a market capitalization of R$1.29b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

BrasilAgro - Companhia Brasileira de Propriedades Agrícolas's net debt of 2.4 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.9 times its interest expenses harmonizes with that theme. Shareholders should be aware that BrasilAgro - Companhia Brasileira de Propriedades Agrícolas's EBIT was down 29% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine BrasilAgro - Companhia Brasileira de Propriedades Agrícolas's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, BrasilAgro - Companhia Brasileira de Propriedades Agrícolas reported free cash flow worth 4.2% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over BrasilAgro - Companhia Brasileira de Propriedades Agrícolas's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, we think it's fair to say that BrasilAgro - Companhia Brasileira de Propriedades Agrícolas has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for BrasilAgro - Companhia Brasileira de Propriedades Agrícolas that you should be aware of.

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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