We Think Azzas 2154 (BVMF:AZZA3) Can Stay On Top Of 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Azzas 2154 S.A. (BVMF:AZZA3) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Azzas 2154

How Much Debt Does Azzas 2154 Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Azzas 2154 had debt of R$2.46b, up from R$1.09b in one year. However, because it has a cash reserve of R$766.4m, its net debt is less, at about R$1.69b.

How Strong Is Azzas 2154's Balance Sheet?

According to the last reported balance sheet, Azzas 2154 had liabilities of R$3.71b due within 12 months, and liabilities of R$3.32b due beyond 12 months. Offsetting these obligations, it had cash of R$766.4m as well as receivables valued at R$3.50b due within 12 months. So it has liabilities totalling R$2.76b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Azzas 2154 is worth R$7.59b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Azzas 2154 has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.0 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. It is well worth noting that Azzas 2154's EBIT shot up like bamboo after rain, gaining 51% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Azzas 2154 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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, Azzas 2154 recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On our analysis Azzas 2154's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. When we consider all the factors mentioned above, we do feel a bit cautious about Azzas 2154's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 example, we've discovered 2 warning signs for Azzas 2154 (1 is potentially serious!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.