These 4 Measures Indicate That Aeris Indústria e Comércio de Equipamentos para Geração de Energia (BVMF:AERI3) Is Using Debt In A Risky Way

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. 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 real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Aeris Indústria e Comércio de Equipamentos para Geração de Energia

How Much Debt Does Aeris Indústria e Comércio de Equipamentos para Geração de Energia Carry?

You can click the graphic below for the historical numbers, but it shows that Aeris Indústria e Comércio de Equipamentos para Geração de Energia had R$1.45b of debt in September 2024, down from R$1.77b, one year before. However, it does have R$881.3m in cash offsetting this, leading to net debt of about R$572.1m.

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

The latest balance sheet data shows that Aeris Indústria e Comércio de Equipamentos para Geração de Energia had liabilities of R$1.88b due within a year, and liabilities of R$665.0m falling due after that. Offsetting these obligations, it had cash of R$881.3m as well as receivables valued at R$724.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$936.5m.

This deficit casts a shadow over the R$425.3m company, like a colossus towering over mere mortals. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Aeris Indústria e Comércio de Equipamentos para Geração de Energia's net debt to EBITDA ratio of 4.1, we think its super-low interest cover of 0.49 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, Aeris Indústria e Comércio de Equipamentos para Geração de Energia saw its EBIT tank 75% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Aeris Indústria e Comércio de Equipamentos para Geração de Energia burned a lot of cash. 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. 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. To that end, you should learn about the 4 warning signs we've spotted with Aeris Indústria e Comércio de Equipamentos para Geração de Energia (including 3 which make us uncomfortable) .

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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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.