Arezzo Indústria e Comércio (BVMF:ARZZ3) Seems To Use Debt Rather Sparingly

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. As with many other companies Arezzo Indústria e Comércio S.A. (BVMF:ARZZ3) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Arezzo Indústria e Comércio

What Is Arezzo Indústria e Comércio's Debt?

The image below, which you can click on for greater detail, shows that Arezzo Indústria e Comércio had debt of R$284.0m at the end of March 2022, a reduction from R$663.9m over a year. However, its balance sheet shows it holds R$480.8m in cash, so it actually has R$196.8m net cash.

How Healthy Is Arezzo Indústria e Comércio's Balance Sheet?

The latest balance sheet data shows that Arezzo Indústria e Comércio had liabilities of R$1.27b due within a year, and liabilities of R$256.6m falling due after that. On the other hand, it had cash of R$480.8m and R$841.9m worth of receivables due within a year. So its liabilities total R$203.2m more than the combination of its cash and short-term receivables.

Since publicly traded Arezzo Indústria e Comércio shares are worth a total of R$8.47b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Arezzo Indústria e Comércio boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Arezzo Indústria e Comércio grew its EBIT by 547% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Arezzo Indústria e Comércio'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, a company can only pay off debt with cold hard cash, not accounting profits. While Arezzo Indústria e Comércio has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Arezzo Indústria e Comércio's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Arezzo Indústria e Comércio has R$196.8m in net cash. And we liked the look of last year's 547% year-on-year EBIT growth. So is Arezzo Indústria e Comércio's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 2 warning signs we've spotted with Arezzo Indústria e Comércio (including 1 which is potentially serious) .

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.