Is Aeris Indústria e Comércio de Equipamentos para Geração de Energia (BVMF:AERI3) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Aeris Indústria e Comércio de Equipamentos para Geração de Energia S.A. (BVMF:AERI3) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, 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$1.54b at the end of June 2024, a reduction from R$1.78b over a year. However, it does have R$977.4m in cash offsetting this, leading to net debt of about R$566.3m.

How Strong Is Aeris Indústria e Comércio de Equipamentos para Geração de Energia's Balance Sheet?

We can see from the most recent balance sheet that Aeris Indústria e Comércio de Equipamentos para Geração de Energia had liabilities of R$1.53b falling due within a year, and liabilities of R$1.03b due beyond that. Offsetting these obligations, it had cash of R$977.4m as well as receivables valued at R$650.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$932.8m.

The deficiency here weighs heavily on the R$445.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Aeris Indústria e Comércio de Equipamentos para Geração de Energia would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Aeris Indústria e Comércio de Equipamentos para Geração de Energia's debt to EBITDA ratio (3.3) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Aeris Indústria e Comércio de Equipamentos para Geração de Energia saw its EBIT tank 63% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

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. 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

To be frank both Aeris Indústria e Comércio de Equipamentos para Geração de Energia's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. It looks to us like Aeris Indústria e Comércio de Equipamentos para Geração de Energia carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Aeris Indústria e Comércio de Equipamentos para Geração de Energia (3 shouldn't be ignored!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.