HBR Realty Empreendimentos Imobiliários (BVMF:HBRE3) Has A Somewhat Strained Balance Sheet

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.' 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. We can see that HBR Realty Empreendimentos Imobiliários S.A. (BVMF:HBRE3) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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 HBR Realty Empreendimentos Imobiliários

What Is HBR Realty Empreendimentos Imobiliários's Debt?

As you can see below, at the end of September 2023, HBR Realty Empreendimentos Imobiliários had R$1.17b of debt, up from R$1.09b a year ago. Click the image for more detail. However, it does have R$43.3m in cash offsetting this, leading to net debt of about R$1.12b.

How Strong Is HBR Realty Empreendimentos Imobiliários' Balance Sheet?

We can see from the most recent balance sheet that HBR Realty Empreendimentos Imobiliários had liabilities of R$263.5m falling due within a year, and liabilities of R$1.54b due beyond that. Offsetting these obligations, it had cash of R$43.3m as well as receivables valued at R$34.1m due within 12 months. So its liabilities total R$1.73b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$517.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, HBR Realty Empreendimentos Imobiliários would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Weak interest cover of 0.91 times and a disturbingly high net debt to EBITDA ratio of 12.9 hit our confidence in HBR Realty Empreendimentos Imobiliários like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Looking on the bright side, HBR Realty Empreendimentos Imobiliários boosted its EBIT by a silky 32% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if HBR Realty Empreendimentos Imobiliários can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, HBR Realty Empreendimentos Imobiliários actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both HBR Realty Empreendimentos Imobiliários's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that HBR Realty Empreendimentos Imobiliários's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For instance, we've identified 5 warning signs for HBR Realty Empreendimentos Imobiliários (2 are a bit unpleasant) you should be aware of.

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.