Mills Estruturas e Serviços de Engenharia (BVMF:MILS3) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Mills Estruturas e Serviços de Engenharia S.A. (BVMF:MILS3) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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.

See our latest analysis for Mills Estruturas e Serviços de Engenharia

What Is Mills Estruturas e Serviços de Engenharia's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Mills Estruturas e Serviços de Engenharia had R$125.8m of debt, an increase on R$96.6m, over one year. But it also has R$262.2m in cash to offset that, meaning it has R$136.4m net cash.

How Strong Is Mills Estruturas e Serviços de Engenharia's Balance Sheet?

The latest balance sheet data shows that Mills Estruturas e Serviços de Engenharia had liabilities of R$120.0m due within a year, and liabilities of R$181.3m falling due after that. On the other hand, it had cash of R$262.2m and R$93.9m worth of receivables due within a year. So it actually has R$54.8m more liquid assets than total liabilities.

This surplus suggests that Mills Estruturas e Serviços de Engenharia has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Mills Estruturas e Serviços de Engenharia has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, Mills Estruturas e Serviços de Engenharia made a loss at the EBIT level, last year, but improved that to positive EBIT of R$31m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Mills Estruturas e Serviços de Engenharia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Mills Estruturas e Serviços de Engenharia 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 year, Mills Estruturas e Serviços de Engenharia actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Mills Estruturas e Serviços de Engenharia has R$136.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 430% of that EBIT to free cash flow, bringing in R$131m. So we don't think Mills Estruturas e Serviços de Engenharia's use of debt is risky. While Mills Estruturas e Serviços de Engenharia didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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