Here's Why Enauta Participações (BVMF:ENAT3) Can Manage Its Debt Responsibly

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. Importantly, Enauta Participações S.A. (BVMF:ENAT3) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Enauta Participações

What Is Enauta Participações's Net Debt?

As you can see below, at the end of March 2023, Enauta Participações had R$1.38b of debt, up from R$148.2m a year ago. Click the image for more detail. However, it does have R$2.04b in cash offsetting this, leading to net cash of R$658.3m.

A Look At Enauta Participações' Liabilities

We can see from the most recent balance sheet that Enauta Participações had liabilities of R$1.45b falling due within a year, and liabilities of R$2.28b due beyond that. Offsetting these obligations, it had cash of R$2.04b as well as receivables valued at R$194.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.50b.

Enauta Participações has a market capitalization of R$3.60b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Enauta Participações also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Enauta Participações grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Enauta Participações can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Enauta Participações may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Enauta Participações recorded free cash flow worth 68% 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.

Summing Up

Although Enauta Participações's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$658.3m. And we liked the look of last year's 26% year-on-year EBIT growth. So we don't think Enauta Participações's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Enauta Participações (1 doesn't sit too well with us) you should be aware of.

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.