Does Ouro Fino Saúde Animal Participações (BVMF:OFSA3) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Ouro Fino Saúde Animal Participações S.A. (BVMF:OFSA3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ouro Fino Saúde Animal Participações

How Much Debt Does Ouro Fino Saúde Animal Participações Carry?

As you can see below, at the end of September 2020, Ouro Fino Saúde Animal Participações had R$319.1m of debt, up from R$298.3m a year ago. Click the image for more detail. However, it does have R$168.7m in cash offsetting this, leading to net debt of about R$150.4m.

How Strong Is Ouro Fino Saúde Animal Participações' Balance Sheet?

The latest balance sheet data shows that Ouro Fino Saúde Animal Participações had liabilities of R$222.9m due within a year, and liabilities of R$225.9m falling due after that. Offsetting this, it had R$168.7m in cash and R$211.7m in receivables that were due within 12 months. So its liabilities total R$68.4m more than the combination of its cash and short-term receivables.

Of course, Ouro Fino Saúde Animal Participações has a market capitalization of R$1.79b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ouro Fino Saúde Animal Participações has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 10.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Ouro Fino Saúde Animal Participações has boosted its EBIT by 62%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ouro Fino Saúde Animal Participações's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Ouro Fino Saúde Animal Participações recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Ouro Fino Saúde Animal Participações's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Zooming out, Ouro Fino Saúde Animal Participações seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 example, we've discovered 2 warning signs for Ouro Fino Saúde Animal Participações that you should be aware of before investing here.

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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