Aeris Indústria e Comércio de Equipamentos para Geração de Energia (BVMF:AERI3) Seems To Use Debt Quite Sensibly

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.' 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 Aeris Indústria e Comércio de Equipamentos para Geração de Energia S.A. (BVMF:AERI3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Aeris Indústria e Comércio de Equipamentos para Geração de Energia

What Is Aeris Indústria e Comércio de Equipamentos para Geração de Energia's Net Debt?

The image below, which you can click on for greater detail, shows that Aeris Indústria e Comércio de Equipamentos para Geração de Energia had debt of R$1.70b at the end of December 2023, a reduction from R$1.82b over a year. However, it also had R$1.06b in cash, and so its net debt is R$632.1m.

A Look At Aeris Indústria e Comércio de Equipamentos para Geração de Energia's Liabilities

We can see from the most recent balance sheet that Aeris Indústria e Comércio de Equipamentos para Geração de Energia had liabilities of R$1.70b falling due within a year, and liabilities of R$1.18b due beyond that. Offsetting this, it had R$1.06b in cash and R$812.0m in receivables that were due within 12 months. So its liabilities total R$1.00b more than the combination of its cash and short-term receivables.

Of course, Aeris Indústria e Comércio de Equipamentos para Geração de Energia has a market capitalization of R$13.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Even though Aeris Indústria e Comércio de Equipamentos para Geração de Energia's debt is only 1.9, its interest cover is really very low at 1.4. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. It is well worth noting that Aeris Indústria e Comércio de Equipamentos para Geração de Energia's EBIT shot up like bamboo after rain, gaining 46% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aeris Indústria e Comércio de Equipamentos para Geração de Energia'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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, Aeris Indústria e Comércio de Equipamentos para Geração de Energia saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We weren't impressed with Aeris Indústria e Comércio de Equipamentos para Geração de Energia's interest cover, and its conversion of EBIT to free cash flow made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble growing its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Aeris Indústria e Comércio de Equipamentos para Geração de Energia's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Aeris Indústria e Comércio de Equipamentos para Geração de Energia is showing 3 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.