These 4 Measures Indicate That Ouro Fino Saúde Animal Participações (BVMF:OFSA3) Is Using Debt Reasonably Well

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 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. We note that Ouro Fino Saúde Animal Participações S.A. (BVMF:OFSA3) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ouro Fino Saúde Animal Participações

How Much Debt Does Ouro Fino Saúde Animal Participações Carry?

The chart below, which you can click on for greater detail, shows that Ouro Fino Saúde Animal Participações had R$395.4m in debt in March 2022; about the same as the year before. On the flip side, it has R$147.4m in cash leading to net debt of about R$248.0m.

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

Zooming in on the latest balance sheet data, we can see that Ouro Fino Saúde Animal Participações had liabilities of R$224.1m due within 12 months and liabilities of R$326.6m due beyond that. Offsetting these obligations, it had cash of R$147.4m as well as receivables valued at R$231.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$171.6m.

Of course, Ouro Fino Saúde Animal Participações has a market capitalization of R$1.18b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Ouro Fino Saúde Animal Participações has a low net debt to EBITDA ratio of only 1.5. And its EBIT easily covers its interest expense, being 11.3 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Ouro Fino Saúde Animal Participações grew its EBIT by 4.7% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ouro Fino Saúde Animal Participações'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ouro Fino Saúde Animal Participações reported free cash flow worth 11% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Ouro Fino Saúde Animal Participações was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Considering this range of data points, we think Ouro Fino Saúde Animal Participações is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Over time, share prices tend to follow earnings per share, so if you're interested in Ouro Fino Saúde Animal Participações, you may well want to click here to check an interactive graph of its earnings per share history.

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.