SLC Agrícola (BVMF:SLCE3) Seems To Use Debt Quite Sensibly

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. We can see that SLC Agrícola S.A. (BVMF:SLCE3) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for SLC Agrícola

What Is SLC Agrícola's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 SLC Agrícola had debt of R$4.43b, up from R$3.07b in one year. However, it also had R$1.32b in cash, and so its net debt is R$3.10b.

How Healthy Is SLC Agrícola's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SLC Agrícola had liabilities of R$4.22b due within 12 months and liabilities of R$5.80b due beyond that. On the other hand, it had cash of R$1.32b and R$439.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$8.26b.

This is a mountain of leverage relative to its market capitalization of R$9.91b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

SLC Agrícola has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 11.4 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that SLC Agrícola has boosted its EBIT by 62%, thus reducing the spectre of future debt repayments. 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 SLC Agrícola 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, SLC Agrícola recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

SLC Agrícola's EBIT growth rate was a real positive on this analysis, as was its interest cover. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that SLC Agrícola is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for SLC Agrícola you should be aware of, and 1 of them is significant.

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.