Ouro Fino Saúde Animal Participações (BVMF:OFSA3) Has A Pretty Healthy Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Ouro Fino Saúde Animal Participações S.A. (BVMF:OFSA3) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

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 March 2021, Ouro Fino Saúde Animal Participações had R$387.4m of debt, up from R$340.8m a year ago. Click the image for more detail. However, it also had R$236.9m in cash, and so its net debt is R$150.5m.

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

The latest balance sheet data shows that Ouro Fino Saúde Animal Participações had liabilities of R$242.2m due within a year, and liabilities of R$296.8m falling due after that. On the other hand, it had cash of R$236.9m and R$199.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$102.7m.

Of course, Ouro Fino Saúde Animal Participações has a market capitalization of R$1.96b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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's net debt is only 0.95 times its EBITDA. And its EBIT covers its interest expense a whopping 11.1 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Ouro Fino Saúde Animal Participações grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Ouro Fino Saúde Animal Participações recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Ouro Fino Saúde Animal Participações's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Ouro Fino Saúde Animal Participações takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Ouro Fino Saúde Animal Participações , and understanding them should be part of your investment process.

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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