Here's Why Restoque Comércio e Confecções de Roupas (BVMF:LLIS3) Is Weighed Down By Its Debt Load

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. Importantly, Restoque Comércio e Confecções de Roupas S.A. (BVMF:LLIS3) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Restoque Comércio e Confecções de Roupas

How Much Debt Does Restoque Comércio e Confecções de Roupas Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Restoque Comércio e Confecções de Roupas had debt of R$1.56b, up from R$1.45b in one year. However, because it has a cash reserve of R$58.9m, its net debt is less, at about R$1.50b.

A Look At Restoque Comércio e Confecções de Roupas' Liabilities

Zooming in on the latest balance sheet data, we can see that Restoque Comércio e Confecções de Roupas had liabilities of R$428.9m due within 12 months and liabilities of R$1.56b due beyond that. Offsetting these obligations, it had cash of R$58.9m as well as receivables valued at R$152.4m due within 12 months. So its liabilities total R$1.78b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$123.9m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Restoque Comércio e Confecções de Roupas would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Restoque Comércio e Confecções de Roupas's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 5.0 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We also note that Restoque Comércio e Confecções de Roupas improved its EBIT from a last year's loss to a positive R$586m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Restoque Comércio e Confecções de Roupas'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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, Restoque Comércio e Confecções de Roupas created free cash flow amounting to 9.6% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Restoque Comércio e Confecções de Roupas's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least its EBIT growth rate is not so bad. We're quite clear that we consider Restoque Comércio e Confecções de Roupas to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. We've identified 3 warning signs with Restoque Comércio e Confecções de Roupas , and understanding them should be part of your investment process.

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.

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.

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