These 4 Measures Indicate That Orizon Valorização de Resíduos (BVMF:ORVR3) Is Using Debt Extensively

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 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. As with many other companies Orizon Valorização de Resíduos S.A. (BVMF:ORVR3) makes use of 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Orizon Valorização de Resíduos

What Is Orizon Valorização de Resíduos's Debt?

As you can see below, at the end of March 2024, Orizon Valorização de Resíduos had R$1.13b of debt, up from R$1.02b a year ago. Click the image for more detail. On the flip side, it has R$272.9m in cash leading to net debt of about R$859.6m.

How Strong Is Orizon Valorização de Resíduos' Balance Sheet?

According to the last reported balance sheet, Orizon Valorização de Resíduos had liabilities of R$265.6m due within 12 months, and liabilities of R$1.24b due beyond 12 months. On the other hand, it had cash of R$272.9m and R$219.8m worth of receivables due within a year. So it has liabilities totalling R$1.01b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Orizon Valorização de Resíduos has a market capitalization of R$3.73b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

While Orizon Valorização de Resíduos has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 1.9. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Pleasingly, Orizon Valorização de Resíduos is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 391% gain in the last twelve months. 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 Orizon Valorização de Resíduos'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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Orizon Valorização de Resíduos saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither Orizon Valorização de Resíduos's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. We think that Orizon Valorização de Resíduos's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 instance, we've identified 2 warning signs for Orizon Valorização de Resíduos that you should be aware of.

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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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.