We Think Sendas Distribuidora (BVMF:ASAI3) Is Taking Some Risk With Its Debt

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 Sendas Distribuidora S.A. (BVMF:ASAI3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sendas Distribuidora

What Is Sendas Distribuidora's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Sendas Distribuidora had debt of R$17.7b, up from R$13.2b in one year. However, it does have R$5.16b in cash offsetting this, leading to net debt of about R$12.6b.

How Strong Is Sendas Distribuidora's Balance Sheet?

We can see from the most recent balance sheet that Sendas Distribuidora had liabilities of R$18.7b falling due within a year, and liabilities of R$20.5b due beyond that. Offsetting this, it had R$5.16b in cash and R$3.24b in receivables that were due within 12 months. So it has liabilities totalling R$30.8b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the R$9.83b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sendas Distribuidora 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about Sendas Distribuidora's net debt to EBITDA ratio of 2.8, we think its super-low interest cover of 1.3 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, one redeeming factor is that Sendas Distribuidora grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. 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 Sendas Distribuidora'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Sendas Distribuidora's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Sendas Distribuidora's interest cover 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. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that Sendas Distribuidora's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 3 warning signs with Sendas Distribuidora (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.