We Think Allpark Empreendimentos Participações e Serviços (BVMF:ALPK3) Is Taking Some Risk With Its Debt

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 Allpark Empreendimentos, Participações e Serviços S.A. (BVMF:ALPK3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Allpark Empreendimentos Participações e Serviços

How Much Debt Does Allpark Empreendimentos Participações e Serviços Carry?

As you can see below, at the end of June 2024, Allpark Empreendimentos Participações e Serviços had R$1.08b of debt, up from R$1.02b a year ago. Click the image for more detail. However, because it has a cash reserve of R$304.4m, its net debt is less, at about R$773.3m.

A Look At Allpark Empreendimentos Participações e Serviços' Liabilities

Zooming in on the latest balance sheet data, we can see that Allpark Empreendimentos Participações e Serviços had liabilities of R$717.9m due within 12 months and liabilities of R$1.57b due beyond that. Offsetting this, it had R$304.4m in cash and R$175.9m in receivables that were due within 12 months. So its liabilities total R$1.81b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R$625.7m 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'd watch its balance sheet closely, without a doubt. After all, Allpark Empreendimentos Participações e Serviços would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though Allpark Empreendimentos Participações e Serviços's debt is only 2.1, its interest cover is really very low at 1.2. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. It is well worth noting that Allpark Empreendimentos Participações e Serviços's EBIT shot up like bamboo after rain, gaining 39% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Allpark Empreendimentos Participações e Serviços can strengthen its balance sheet over time. 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 always check how much of that EBIT is translated into free cash flow. Over the last three years, Allpark Empreendimentos Participações e Serviços actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about Allpark Empreendimentos Participações e Serviços's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. When we consider all the factors discussed, it seems to us that Allpark Empreendimentos Participações e Serviços is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Allpark Empreendimentos Participações e Serviços that you should be aware of before investing here.

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.