Here's Why Eternit (BVMF:ETER3) Is Weighed Down By Its Debt Load

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Eternit S.A. (BVMF:ETER3) does carry debt. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Eternit's Debt?

The image below, which you can click on for greater detail, shows that at March 2025 Eternit had debt of R$137.3m, up from R$129.6m in one year. However, it does have R$25.7m in cash offsetting this, leading to net debt of about R$111.5m.

How Healthy Is Eternit's Balance Sheet?

The latest balance sheet data shows that Eternit had liabilities of R$302.7m due within a year, and liabilities of R$205.5m falling due after that. On the other hand, it had cash of R$25.7m and R$234.8m worth of receivables due within a year. So its liabilities total R$247.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of R$248.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

Check out our latest analysis for Eternit

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 1.4 times EBITDA, it is initially surprising to see that Eternit's EBIT has low interest coverage of 1.3 times. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Eternit's EBIT was down 51% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Eternit recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Eternit's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Eternit has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. To that end, you should be aware of the 4 warning signs we've spotted with Eternit .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.