Smartfit Escola de Ginástica e Dança (BVMF:SMFT3) Has A Somewhat Strained Balance Sheet

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 Smartfit Escola de Ginástica e Dança S.A. (BVMF:SMFT3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Smartfit Escola de Ginástica e Dança

What Is Smartfit Escola de Ginástica e Dança's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Smartfit Escola de Ginástica e Dança had R$3.46b of debt, an increase on R$3.07b, over one year. On the flip side, it has R$2.77b in cash leading to net debt of about R$697.5m.

How Healthy Is Smartfit Escola de Ginástica e Dança's Balance Sheet?

The latest balance sheet data shows that Smartfit Escola de Ginástica e Dança had liabilities of R$2.37b due within a year, and liabilities of R$6.09b falling due after that. Offsetting these obligations, it had cash of R$2.77b as well as receivables valued at R$697.0m due within 12 months. So it has liabilities totalling R$4.99b more than its cash and near-term receivables, combined.

Smartfit Escola de Ginástica e Dança has a market capitalization of R$14.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Smartfit Escola de Ginástica e Dança has a very low debt to EBITDA ratio of 0.60 so it is strange to see weak interest coverage, with last year's EBIT being only 2.3 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Pleasingly, Smartfit Escola de Ginástica e Dança is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 1,585% gain in the last twelve months. 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 Smartfit Escola de Ginástica e Dança'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. During the last two years, Smartfit Escola de Ginástica e Dança burned a lot of cash. 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

Neither Smartfit Escola de Ginástica e Dança's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Smartfit Escola de Ginástica e Dança's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Be aware that Smartfit Escola de Ginástica e Dança is showing 1 warning sign in our investment analysis , you should know about...

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.