These 4 Measures Indicate That Eternit (BVMF:ETER3) Is Using Debt Reasonably Well

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 is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Eternit

How Much Debt Does Eternit Carry?

As you can see below, Eternit had R$66.4m of debt at December 2020, down from R$163.6m a year prior. But it also has R$81.2m in cash to offset that, meaning it has R$14.8m net cash.

A Look At Eternit's Liabilities

We can see from the most recent balance sheet that Eternit had liabilities of R$221.2m falling due within a year, and liabilities of R$309.0m due beyond that. On the other hand, it had cash of R$81.2m and R$178.9m worth of receivables due within a year. So it has liabilities totalling R$270.2m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Eternit has a market capitalization of R$968.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Eternit also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Eternit made a loss at the EBIT level, last year, it was also good to see that it generated R$268m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. In the last year, Eternit's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Eternit does have more liabilities than liquid assets, it also has net cash of R$14.8m. 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Eternit (2 are concerning) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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