Here's Why Eternit (BVMF:ETER3) Can Manage Its Debt Responsibly

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Eternit S.A. (BVMF:ETER3) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Eternit

What Is Eternit's Net Debt?

As you can see below, Eternit had R$44.5m of debt at June 2021, down from R$96.9m a year prior. However, its balance sheet shows it holds R$196.7m in cash, so it actually has R$152.1m net cash.

How Healthy Is Eternit's Balance Sheet?

The latest balance sheet data shows that Eternit had liabilities of R$173.9m due within a year, and liabilities of R$277.2m falling due after that. Offsetting this, it had R$196.7m in cash and R$262.0m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Eternit's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the R$1.12b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Eternit boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Eternit made a loss at the EBIT level, last year, it was also good to see that it generated R$417m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Eternit's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Eternit 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. Looking at the most recent year, Eternit recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Eternit has net cash of R$152.1m, as well as more liquid assets than liabilities. So we don't have any problem with Eternit's use of debt. 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. Case in point: We've spotted 3 warning signs for Eternit you should be aware of, and 1 of them is a bit concerning.

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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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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