Is Guararapes Confecções (BVMF:GUAR3) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Guararapes Confecções S.A. (BVMF:GUAR3) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Guararapes Confecções

What Is Guararapes Confecções's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Guararapes Confecções had R$3.86b of debt, an increase on R$2.93b, over one year. However, it does have R$2.75b in cash offsetting this, leading to net debt of about R$1.11b.

How Healthy Is Guararapes Confecções' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guararapes Confecções had liabilities of R$4.72b due within 12 months and liabilities of R$3.71b due beyond that. Offsetting these obligations, it had cash of R$2.75b as well as receivables valued at R$3.81b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.86b.

Given Guararapes Confecções has a market capitalization of R$10.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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 Guararapes Confecções'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.

In the last year Guararapes Confecções had a loss before interest and tax, and actually shrunk its revenue by 25%, to R$5.9b. That makes us nervous, to say the least.

Caveat Emptor

While Guararapes Confecções's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost R$179m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of R$85m into a profit. In the meantime, we consider the stock very risky. 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. We've identified 3 warning signs with Guararapes Confecções , and understanding them should be part of your investment process.

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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