Is Cyrela Commercial Properties (BVMF:CCPR3) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Cyrela Commercial Properties S.A. (BVMF:CCPR3) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Cyrela Commercial Properties

What Is Cyrela Commercial Properties's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Cyrela Commercial Properties had R$1.90b of debt, an increase on R$1.71b, over one year. However, it does have R$612.8m in cash offsetting this, leading to net debt of about R$1.28b.

How Healthy Is Cyrela Commercial Properties' Balance Sheet?

We can see from the most recent balance sheet that Cyrela Commercial Properties had liabilities of R$184.5m falling due within a year, and liabilities of R$1.79b due beyond that. Offsetting this, it had R$612.8m in cash and R$103.8m in receivables that were due within 12 months. So its liabilities total R$1.26b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of R$1.98b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Cyrela Commercial Properties's debt is 3.8 times its EBITDA, and its EBIT cover its interest expense 3.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. On a lighter note, we note that Cyrela Commercial Properties grew its EBIT by 27% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cyrela Commercial Properties can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Cyrela Commercial Properties produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both Cyrela Commercial Properties's ability to to grow its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. On the other hand, its interest cover makes us a little less comfortable about its debt. Considering this range of data points, we think Cyrela Commercial Properties is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Cyrela Commercial Properties , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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