Does Ambipar Participações e Empreendimentos (BVMF:AMBP3) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Ambipar Participações e Empreendimentos S.A. (BVMF:AMBP3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ambipar Participações e Empreendimentos

What Is Ambipar Participações e Empreendimentos's Debt?

As you can see below, at the end of September 2023, Ambipar Participações e Empreendimentos had R$6.96b of debt, up from R$5.38b a year ago. Click the image for more detail. However, because it has a cash reserve of R$2.56b, its net debt is less, at about R$4.40b.

How Strong Is Ambipar Participações e Empreendimentos' Balance Sheet?

We can see from the most recent balance sheet that Ambipar Participações e Empreendimentos had liabilities of R$1.93b falling due within a year, and liabilities of R$6.85b due beyond that. Offsetting this, it had R$2.56b in cash and R$1.40b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$4.83b.

This deficit casts a shadow over the R$2.59b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ambipar Participações e Empreendimentos would likely require a major re-capitalisation if it had to pay its creditors today.

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 Ambipar Participações e Empreendimentos's debt to EBITDA ratio (3.9) suggests that it uses some debt, its interest cover is very weak, at 1.3, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, Ambipar Participações e Empreendimentos boosted its EBIT by a silky 51% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position 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 Ambipar Participações e Empreendimentos can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ambipar Participações e Empreendimentos 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

To be frank both Ambipar Participações e Empreendimentos's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, it seems to us that Ambipar Participações e Empreendimentos's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. To that end, you should learn about the 2 warning signs we've spotted with Ambipar Participações e Empreendimentos (including 1 which doesn't sit too well with us) .

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.