Is Mitre Realty Empreendimentos e Participações (BVMF:MTRE3) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Mitre Realty Empreendimentos e Participações S.A. (BVMF:MTRE3) does have debt on its balance sheet. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Mitre Realty Empreendimentos e Participações

What Is Mitre Realty Empreendimentos e Participações's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Mitre Realty Empreendimentos e Participações had R$581.0m of debt, an increase on R$281.1m, over one year. However, it also had R$176.1m in cash, and so its net debt is R$404.9m.

How Strong Is Mitre Realty Empreendimentos e Participações' Balance Sheet?

We can see from the most recent balance sheet that Mitre Realty Empreendimentos e Participações had liabilities of R$603.2m falling due within a year, and liabilities of R$499.6m due beyond that. On the other hand, it had cash of R$176.1m and R$595.3m worth of receivables due within a year. So it has liabilities totalling R$331.4m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of R$504.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Mitre Realty Empreendimentos e Participações has a sky high EBITDA ratio of 7.8, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Sadly, Mitre Realty Empreendimentos e Participações's EBIT actually dropped 9.2% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mitre Realty Empreendimentos e 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.

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, Mitre Realty Empreendimentos e Participações saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Mitre Realty Empreendimentos e Participações's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Mitre Realty Empreendimentos e Participações to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 instance, we've identified 3 warning signs for Mitre Realty Empreendimentos e Participações (2 shouldn't be ignored) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.