Is Enauta Participações (BVMF:ENAT3) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Enauta Participações S.A. (BVMF:ENAT3) makes use of 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for Enauta Participações

How Much Debt Does Enauta Participações Carry?

As you can see below, at the end of June 2023, Enauta Participações had R$1.34b of debt, up from R$135.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds R$1.78b in cash, so it actually has R$436.6m net cash.

How Healthy Is Enauta Participações' Balance Sheet?

According to the last reported balance sheet, Enauta Participações had liabilities of R$1.62b due within 12 months, and liabilities of R$2.05b due beyond 12 months. Offsetting this, it had R$1.78b in cash and R$130.1m in receivables that were due within 12 months. So it has liabilities totalling R$1.77b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Enauta Participações has a market capitalization of R$3.91b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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.

In fact Enauta Participações's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. In the last three years, Enauta Participações's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While Enauta Participações does have more liabilities than liquid assets, it also has net cash of R$436.6m. So although we see some areas for improvement, we're not too worried about Enauta Participações's balance sheet. 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. Be aware that Enauta Participações is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.