Grendene (BVMF:GRND3) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Grendene S.A. (BVMF:GRND3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Grendene

How Much Debt Does Grendene Carry?

You can click the graphic below for the historical numbers, but it shows that Grendene had R$106.6m of debt in December 2022, down from R$124.3m, one year before. But on the other hand it also has R$1.18b in cash, leading to a R$1.07b net cash position.

How Healthy Is Grendene's Balance Sheet?

According to the last reported balance sheet, Grendene had liabilities of R$408.0m due within 12 months, and liabilities of R$49.8m due beyond 12 months. Offsetting this, it had R$1.18b in cash and R$1.36b in receivables that were due within 12 months. So it can boast R$2.09b more liquid assets than total liabilities.

This luscious liquidity implies that Grendene's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Grendene boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Grendene if management cannot prevent a repeat of the 32% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Grendene 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Grendene may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Grendene recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Grendene has R$1.07b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of R$363m, being 85% of its EBIT. So is Grendene's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Grendene (including 2 which make us uncomfortable) .

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.