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

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 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 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Allpark Empreendimentos Participações e Serviços

How Much Debt Does Allpark Empreendimentos Participações e Serviços Carry?

As you can see below, Allpark Empreendimentos Participações e Serviços had R$828.7m of debt at June 2022, down from R$916.0m a year prior. However, it does have R$52.9m in cash offsetting this, leading to net debt of about R$775.8m.

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

Zooming in on the latest balance sheet data, we can see that Allpark Empreendimentos Participações e Serviços had liabilities of R$734.6m due within 12 months and liabilities of R$1.34b due beyond that. Offsetting this, it had R$52.9m in cash and R$159.2m in receivables that were due within 12 months. So its liabilities total R$1.86b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R$507.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Allpark Empreendimentos Participações e Serviços would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

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 0.51, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Looking on the bright side, Allpark Empreendimentos Participações e Serviços boosted its EBIT by a silky 71% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Allpark Empreendimentos Participações e Serviços saw substantial negative free cash flow, in total. 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 level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Allpark Empreendimentos Participações e Serviços to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Allpark Empreendimentos Participações e Serviços has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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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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.