MRV Engenharia e Participações (BVMF:MRVE3) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that MRV Engenharia e Participações S.A. (BVMF:MRVE3) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for MRV Engenharia e Participações

How Much Debt Does MRV Engenharia e Participações Carry?

As you can see below, MRV Engenharia e Participações had R$8.40b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have R$2.18b in cash offsetting this, leading to net debt of about R$6.22b.

A Look At MRV Engenharia e Participações' Liabilities

Zooming in on the latest balance sheet data, we can see that MRV Engenharia e Participações had liabilities of R$7.16b due within 12 months and liabilities of R$12.3b due beyond that. On the other hand, it had cash of R$2.18b and R$3.49b worth of receivables due within a year. So its liabilities total R$13.8b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R$3.90b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, MRV Engenharia e Participações would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 2.2 times and a disturbingly high net debt to EBITDA ratio of 18.3 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$292m 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 ultimately the future profitability of the business will decide if MRV Engenharia e Participações 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 company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, MRV Engenharia e Participações saw substantial negative free cash flow, in total. 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

On the face of it, MRV Engenharia e Participações's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like MRV Engenharia e Participações has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that MRV Engenharia e Participações is showing 1 warning sign in our investment analysis , you should know about...

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.