Does Fleury (BVMF:FLRY3) Have A Healthy Balance Sheet?

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 Fleury S.A. (BVMF:FLRY3) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Fleury

What Is Fleury's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Fleury had R$1.90b of debt, an increase on R$1.56b, over one year. On the flip side, it has R$1.04b in cash leading to net debt of about R$861.9m.

How Healthy Is Fleury's Balance Sheet?

According to the last reported balance sheet, Fleury had liabilities of R$1.11b due within 12 months, and liabilities of R$2.66b due beyond 12 months. Offsetting these obligations, it had cash of R$1.04b as well as receivables valued at R$754.8m due within 12 months. So it has liabilities totalling R$1.98b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Fleury has a market capitalization of R$8.10b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Looking at its net debt to EBITDA of 1.2 and interest cover of 4.0 times, it seems to us that Fleury is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. The bad news is that Fleury saw its EBIT decline by 12% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 Fleury'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, Fleury recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

When it comes to the balance sheet, the standout positive for Fleury was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. In particular, EBIT growth rate gives us cold feet. It's also worth noting that Fleury is in the Healthcare industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that Fleury 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Fleury you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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