Cyrela Brazil Realty Empreendimentos e Participações (BVMF:CYRE3) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Cyrela Brazil Realty S.A. Empreendimentos e Participações (BVMF:CYRE3) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

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What Is Cyrela Brazil Realty Empreendimentos e Participações's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Cyrela Brazil Realty Empreendimentos e Participações had debt of R$4.02b, up from R$3.35b in one year. However, it also had R$2.40b in cash, and so its net debt is R$1.62b.

How Healthy Is Cyrela Brazil Realty Empreendimentos e Participações' Balance Sheet?

According to the last reported balance sheet, Cyrela Brazil Realty Empreendimentos e Participações had liabilities of R$2.78b due within 12 months, and liabilities of R$4.89b due beyond 12 months. Offsetting these obligations, it had cash of R$2.40b as well as receivables valued at R$1.95b due within 12 months. So its liabilities total R$3.32b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Cyrela Brazil Realty Empreendimentos e Participações has a market capitalization of R$6.82b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Cyrela Brazil Realty Empreendimentos e Participações's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. Sadly, Cyrela Brazil Realty Empreendimentos e Participações's EBIT actually dropped 9.9% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cyrela Brazil Realty Empreendimentos e Participações'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.

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. During the last three years, Cyrela Brazil Realty Empreendimentos e Participações produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both Cyrela Brazil Realty Empreendimentos e Participações's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Cyrela Brazil Realty Empreendimentos e Participações is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Cyrela Brazil Realty Empreendimentos e Participações .

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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