These 4 Measures Indicate That Mills Estruturas e Serviços de Engenharia (BVMF:MILS3) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Mills Estruturas e Serviços de Engenharia S.A. (BVMF:MILS3) 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?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its 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 March 2022 Mills Estruturas e Serviços de Engenharia had R$429.9m of debt, an increase on R$201.6m, over one year. But on the other hand it also has R$516.8m in cash, leading to a R$86.9m net cash position.

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

Zooming in on the latest balance sheet data, we can see that Mills Estruturas e Serviços de Engenharia had liabilities of R$189.9m due within 12 months and liabilities of R$459.6m due beyond that. On the other hand, it had cash of R$516.8m and R$161.6m worth of receivables due within a year. So it actually has R$28.8m more liquid assets than total liabilities.

Having regard to Mills Estruturas e Serviços de Engenharia's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the R$1.74b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Mills Estruturas e Serviços de Engenharia boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Mills Estruturas e Serviços de Engenharia grew its EBIT by 364% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mills Estruturas e Serviços de Engenharia will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept 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 two years, 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$86.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in R$104m. So we don't think Mills Estruturas e Serviços de Engenharia'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. We've identified 1 warning sign with Mills Estruturas e Serviços de Engenharia , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.