Here's Why Texaf (EBR:TEXF) Can Manage Its Debt Responsibly

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.' 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. We note that Texaf S.A. (EBR:TEXF) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Texaf

What Is Texaf's Debt?

As you can see below, Texaf had €1.92m of debt at December 2020, down from €4.27m a year prior. However, its balance sheet shows it holds €6.98m in cash, so it actually has €5.06m net cash.

How Strong Is Texaf's Balance Sheet?

We can see from the most recent balance sheet that Texaf had liabilities of €10.3m falling due within a year, and liabilities of €18.7m due beyond that. Offsetting this, it had €6.98m in cash and €1.46m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €20.6m.

Of course, Texaf has a market capitalization of €125.8m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Texaf also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Texaf saw its EBIT drop by 2.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Texaf 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. While Texaf has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Texaf actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Texaf's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €5.06m. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in €8.3m. So we don't think Texaf's use of debt is risky. 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 instance, we've identified 2 warning signs for Texaf (1 is potentially serious) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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