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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Eternit S.A. (BVMF:ETER3) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Eternit

How Much Debt Does Eternit Carry?

As you can see below, Eternit had R$35.4m of debt at June 2022, down from R$44.5m a year prior. But it also has R$149.2m in cash to offset that, meaning it has R$113.8m net cash.

How Strong Is Eternit's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Eternit had liabilities of R$200.9m due within 12 months and liabilities of R$235.3m due beyond that. Offsetting this, it had R$149.2m in cash and R$335.9m in receivables that were due within 12 months. So it can boast R$48.9m more liquid assets than total liabilities.

This surplus suggests that Eternit has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Eternit boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Eternit's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Eternit will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last two years, Eternit reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay 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$113.8m, as well as more liquid assets than liabilities. So we don't have any problem with Eternit's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Eternit is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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.