Helbor Empreendimentos (BVMF:HBOR3) Has A Somewhat Strained Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Helbor Empreendimentos S.A. (BVMF:HBOR3) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Helbor Empreendimentos

What Is Helbor Empreendimentos's Net Debt?

The image below, which you can click on for greater detail, shows that Helbor Empreendimentos had debt of R$1.32b at the end of June 2021, a reduction from R$1.54b over a year. However, it does have R$426.7m in cash offsetting this, leading to net debt of about R$895.0m.

How Healthy Is Helbor Empreendimentos' Balance Sheet?

The latest balance sheet data shows that Helbor Empreendimentos had liabilities of R$961.5m due within a year, and liabilities of R$1.51b falling due after that. On the other hand, it had cash of R$426.7m and R$586.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.46b.

The deficiency here weighs heavily on the R$849.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Helbor Empreendimentos would likely require a major re-capitalisation if it had to pay its creditors today.

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).

Strangely Helbor Empreendimentos has a sky high EBITDA ratio of 13.2, implying high debt, but a strong interest coverage of 16.8. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. We also note that Helbor Empreendimentos improved its EBIT from a last year's loss to a positive R$54m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Helbor Empreendimentos'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Helbor Empreendimentos recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Helbor Empreendimentos's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Helbor Empreendimentos stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Be aware that Helbor Empreendimentos is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...

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.

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.

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