These 4 Measures Indicate That Atacadão (BVMF:CRFB3) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Atacadão S.A. (BVMF:CRFB3) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Atacadão

What Is Atacadão's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Atacadão had debt of R$9.98b, up from R$6.23b in one year. However, because it has a cash reserve of R$2.36b, its net debt is less, at about R$7.62b.

A Look At Atacadão's Liabilities

The latest balance sheet data shows that Atacadão had liabilities of R$24.7b due within a year, and liabilities of R$11.2b falling due after that. Offsetting these obligations, it had cash of R$2.36b as well as receivables valued at R$4.52b due within 12 months. So it has liabilities totalling R$29.0b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of R$30.7b, so it does suggest shareholders should keep an eye on Atacadão's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Atacadão's net debt of 1.5 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.3 times its interest expenses harmonizes with that theme. Fortunately, Atacadão grew its EBIT by 4.6% in the last year, making that debt load look even more manageable. 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 Atacadão'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Atacadão recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Mulling over Atacadão's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Atacadão's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Atacadão (1 can't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.