Here's Why MRV Engenharia e Participações (BVMF:MRVE3) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 MRV Engenharia e Participações S.A. (BVMF:MRVE3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for MRV Engenharia e Participações

How Much Debt Does MRV Engenharia e Participações Carry?

The chart below, which you can click on for greater detail, shows that MRV Engenharia e Participações had R$7.89b in debt in December 2023; about the same as the year before. However, it does have R$2.82b in cash offsetting this, leading to net debt of about R$5.07b.

A Look At MRV Engenharia e Participações' Liabilities

According to the last reported balance sheet, MRV Engenharia e Participações had liabilities of R$5.63b due within 12 months, and liabilities of R$11.9b due beyond 12 months. Offsetting this, it had R$2.82b in cash and R$2.99b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$11.7b.

This deficit casts a shadow over the R$4.06b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, MRV Engenharia e Participações would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Weak interest cover of 0.26 times and a disturbingly high net debt to EBITDA ratio of 38.4 hit our confidence in MRV Engenharia e Participações like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that MRV Engenharia e Participações achieved a positive EBIT of R$63m in the last twelve months, an improvement on the prior year's loss. 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 MRV Engenharia e Participações's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, MRV Engenharia e Participações burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both MRV Engenharia e Participações's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We think the chances that MRV Engenharia e Participações has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. Be aware that MRV Engenharia e Participações is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.