Is Ser Educacional (BVMF:SEER3) A Risky Investment?

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.' 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. Importantly, Ser Educacional S.A. (BVMF:SEER3) does carry debt. But is this debt a concern to shareholders?

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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ser Educacional

How Much Debt Does Ser Educacional Carry?

As you can see below, Ser Educacional had R$560.1m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have R$111.7m in cash offsetting this, leading to net debt of about R$448.4m.

How Healthy Is Ser Educacional's Balance Sheet?

We can see from the most recent balance sheet that Ser Educacional had liabilities of R$498.3m falling due within a year, and liabilities of R$1.39b due beyond that. Offsetting this, it had R$111.7m in cash and R$458.0m in receivables that were due within 12 months. So its liabilities total R$1.32b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$841.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Ser Educacional 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 1.2 times EBITDA, it is initially surprising to see that Ser Educacional's EBIT has low interest coverage of 1.8 times. So while we're not necessarily alarmed we think that its debt is far from trivial. The bad news is that Ser Educacional saw its EBIT decline by 17% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 Ser Educacional 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Ser Educacional recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Ser Educacional'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 converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Ser Educacional'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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Ser Educacional .

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.