Is Unicasa Indústria de Móveis (BVMF:UCAS3) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Unicasa Indústria de Móveis S.A. (BVMF:UCAS3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that UCAS3 is potentially undervalued!

What Is Unicasa Indústria de Móveis's Debt?

The image below, which you can click on for greater detail, shows that Unicasa Indústria de Móveis had debt of R$12.4m at the end of June 2022, a reduction from R$17.1m over a year. However, it does have R$43.3m in cash offsetting this, leading to net cash of R$31.0m.

A Look At Unicasa Indústria de Móveis' Liabilities

We can see from the most recent balance sheet that Unicasa Indústria de Móveis had liabilities of R$98.4m falling due within a year, and liabilities of R$16.0m due beyond that. Offsetting these obligations, it had cash of R$43.3m as well as receivables valued at R$44.3m due within 12 months. So its liabilities total R$26.8m more than the combination of its cash and short-term receivables.

Of course, Unicasa Indústria de Móveis has a market capitalization of R$182.4m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Unicasa Indústria de Móveis boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Unicasa Indústria de Móveis grew its EBIT by 8.7% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is Unicasa Indústria de Móveis's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Unicasa Indústria de Móveis has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Unicasa Indústria de Móveis produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Unicasa Indústria de Móveis does have more liabilities than liquid assets, it also has net cash of R$31.0m. So we don't think Unicasa Indústria de Móveis's use of debt is risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Unicasa Indústria de Móveis (including 1 which doesn't sit too well with us) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.