Allpark Empreendimentos Participações e Serviços (BVMF:ALPK3) Seems To Be Using A Lot Of Debt

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. Importantly, Allpark Empreendimentos, Participações e Serviços S.A. (BVMF:ALPK3) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Allpark Empreendimentos Participações e Serviços

What Is Allpark Empreendimentos Participações e Serviços's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Allpark Empreendimentos Participações e Serviços had R$874.4m of debt, an increase on R$478.0m, over one year. However, it also had R$316.1m in cash, and so its net debt is R$558.3m.

How Strong Is Allpark Empreendimentos Participações e Serviços's Balance Sheet?

According to the last reported balance sheet, Allpark Empreendimentos Participações e Serviços had liabilities of R$899.1m due within 12 months, and liabilities of R$1.88b due beyond 12 months. Offsetting these obligations, it had cash of R$316.1m as well as receivables valued at R$156.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$2.30b.

Given this deficit is actually higher than the company's market capitalization of R$1.81b, we think shareholders really should watch Allpark Empreendimentos Participações e Serviços's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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 Allpark Empreendimentos Participações e Serviços's debt to EBITDA ratio (3.5) suggests that it uses some debt, its interest cover is very weak, at 1.1, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Allpark Empreendimentos Participações e Serviços's EBIT was down 47% over the last year. 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. 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 Allpark Empreendimentos Participações e Serviços'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Allpark Empreendimentos Participações e Serviços reported free cash flow worth 16% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Allpark Empreendimentos Participações e Serviços's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. After considering the datapoints discussed, we think Allpark Empreendimentos Participações e Serviços has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Allpark Empreendimentos Participações e Serviços has 1 warning sign we think you should be aware of.

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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