These 4 Measures Indicate That Smartfit Escola de Ginástica e Dança (BVMF:SMFT3) Is Using Debt Extensively

Warren Buffett famously said, '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. As with many other companies Smartfit Escola de Ginástica e Dança S.A. (BVMF:SMFT3) makes use of debt. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

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

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Smartfit Escola de Ginástica e Dança had R$5.91b of debt, an increase on R$3.82b, over one year. However, because it has a cash reserve of R$2.95b, its net debt is less, at about R$2.97b.

A Look At Smartfit Escola de Ginástica e Dança's Liabilities

According to the last reported balance sheet, Smartfit Escola de Ginástica e Dança had liabilities of R$2.79b due within 12 months, and liabilities of R$10.1b due beyond 12 months. Offsetting these obligations, it had cash of R$2.95b as well as receivables valued at R$1.16b due within 12 months. So its liabilities total R$8.77b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of R$14.1b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

Check out our latest analysis for Smartfit Escola de Ginástica e Dança

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 1.5 so it is strange to see weak interest coverage, with last year's EBIT being only 1.7 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Also relevant is that Smartfit Escola de Ginástica e Dança has grown its EBIT by a very respectable 21% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Smartfit Escola de Ginástica e Dança saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Smartfit Escola de Ginástica e Dança's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Smartfit Escola de Ginástica e Dança'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. Be aware that Smartfit Escola de Ginástica e Dança is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.