Duratex (BVMF:DTEX3) Has A Rock Solid Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Duratex S.A. (BVMF:DTEX3) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Duratex

How Much Debt Does Duratex Carry?

You can click the graphic below for the historical numbers, but it shows that Duratex had R$3.10b of debt in June 2021, down from R$3.78b, one year before. However, it does have R$1.33b in cash offsetting this, leading to net debt of about R$1.77b.

A Look At Duratex's Liabilities

According to the last reported balance sheet, Duratex had liabilities of R$2.52b due within 12 months, and liabilities of R$3.72b due beyond 12 months. Offsetting these obligations, it had cash of R$1.33b as well as receivables valued at R$1.59b due within 12 months. So it has liabilities totalling R$3.32b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Duratex is worth R$14.6b, and thus could probably raise enough capital to shore up 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Duratex's net debt is only 0.76 times its EBITDA. And its EBIT easily covers its interest expense, being 21.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Duratex grew its EBIT by 908% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Duratex 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Duratex generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Duratex's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think Duratex is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Duratex (1 is concerning) you should be aware of.

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.
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