Allpark Empreendimentos Participações e Serviços (BVMF:ALPK3) Use Of Debt Could Be Considered Risky

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Allpark Empreendimentos, Participações e Serviços S.A. (BVMF:ALPK3) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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.

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 December 2020 Allpark Empreendimentos Participações e Serviços had R$865.2m of debt, an increase on R$478.0m, over one year. However, because it has a cash reserve of R$42.1m, its net debt is less, at about R$823.1m.

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

According to the last reported balance sheet, Allpark Empreendimentos Participações e Serviços had liabilities of R$810.4m due within 12 months, and liabilities of R$1.20b due beyond 12 months. On the other hand, it had cash of R$42.1m and R$153.1m worth of receivables due within a year. So its liabilities total R$1.81b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of R$1.46b, 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. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.39 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in Allpark Empreendimentos Participações e Serviços like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Allpark Empreendimentos Participações e Serviços's EBIT was down 64% 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Allpark Empreendimentos Participações e Serviços 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

On the face of it, Allpark Empreendimentos Participações e Serviços's conversion of EBIT to free cash flow 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 net debt to EBITDA fails to inspire much confidence. We think the chances that Allpark Empreendimentos Participações e Serviços has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. For example, we've discovered 3 warning signs for Allpark Empreendimentos Participações e Serviços (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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