Does Eternit (BVMF:ETER3) Have A Healthy 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.' 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. We can see that Eternit S.A. (BVMF:ETER3) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Eternit

What Is Eternit's Debt?

You can click the graphic below for the historical numbers, but it shows that Eternit had R$37.4m of debt in December 2021, down from R$66.4m, one year before. But on the other hand it also has R$218.9m in cash, leading to a R$181.5m net cash position.

How Strong Is Eternit's Balance Sheet?

The latest balance sheet data shows that Eternit had liabilities of R$208.9m due within a year, and liabilities of R$239.7m falling due after that. Offsetting this, it had R$218.9m in cash and R$279.6m in receivables that were due within 12 months. So it can boast R$49.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Eternit could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Eternit boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Eternit grew its EBIT by 159% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Eternit will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Eternit has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent two years, Eternit recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Eternit has net cash of R$181.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 159% year-on-year EBIT growth. So we don't think Eternit's use of debt is risky. 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 Eternit is showing 4 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.