RNI Negócios Imobiliários (BVMF:RDNI3) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that RNI Negócios Imobiliários S.A. (BVMF:RDNI3) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for RNI Negócios Imobiliários

How Much Debt Does RNI Negócios Imobiliários Carry?

The image below, which you can click on for greater detail, shows that at September 2020 RNI Negócios Imobiliários had debt of R$443.2m, up from R$392.2m in one year. However, because it has a cash reserve of R$89.7m, its net debt is less, at about R$353.5m.

How Healthy Is RNI Negócios Imobiliários' Balance Sheet?

According to the last reported balance sheet, RNI Negócios Imobiliários had liabilities of R$338.2m due within 12 months, and liabilities of R$604.3m due beyond 12 months. On the other hand, it had cash of R$89.7m and R$301.9m worth of receivables due within a year. So it has liabilities totalling R$550.9m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of R$464.2m, we think shareholders really should watch RNI Negócios Imobiliários's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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

RNI Negócios Imobiliários has a rather high debt to EBITDA ratio of 22.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.9 times, suggesting it can responsibly service its obligations. One redeeming factor for RNI Negócios Imobiliários is that it turned last year's EBIT loss into a gain of R$13m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is RNI Negócios Imobiliários's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last year, RNI Negócios Imobiliários 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, RNI Negócios Imobiliários's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think RNI Negócios Imobiliários has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with RNI Negócios Imobiliários , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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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