M. Dias Branco Indústria e Comércio de Alimentos (BVMF:MDIA3) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies M. Dias Branco S.A. Indústria e Comércio de Alimentos (BVMF:MDIA3) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for M. Dias Branco Indústria e Comércio de Alimentos

What Is M. Dias Branco Indústria e Comércio de Alimentos's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 M. Dias Branco Indústria e Comércio de Alimentos had debt of R$1.86b, up from R$1.65b in one year. However, its balance sheet shows it holds R$1.88b in cash, so it actually has R$19.5m net cash.

How Healthy Is M. Dias Branco Indústria e Comércio de Alimentos' Balance Sheet?

We can see from the most recent balance sheet that M. Dias Branco Indústria e Comércio de Alimentos had liabilities of R$1.46b falling due within a year, and liabilities of R$2.23b due beyond that. Offsetting this, it had R$1.88b in cash and R$1.43b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$380.1m.

Given M. Dias Branco Indústria e Comércio de Alimentos has a market capitalization of R$10.0b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, M. Dias Branco Indústria e Comércio de Alimentos also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that M. Dias Branco Indústria e Comércio de Alimentos's load is not too heavy, because its EBIT was down 45% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 M. Dias Branco Indústria e Comércio de Alimentos'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. M. Dias Branco Indústria e Comércio de Alimentos 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, M. Dias Branco Indústria e Comércio de Alimentos recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that M. Dias Branco Indústria e Comércio de Alimentos has R$19.5m in net cash. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in R$602m. So we are not troubled with M. Dias Branco Indústria e Comércio de Alimentos's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with M. Dias Branco Indústria e Comércio de Alimentos .

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.

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.

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