Moura Dubeux Engenharia (BVMF:MDNE3) 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.' 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. As with many other companies Moura Dubeux Engenharia S.A. (BVMF:MDNE3) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Moura Dubeux Engenharia

What Is Moura Dubeux Engenharia's Debt?

You can click the graphic below for the historical numbers, but it shows that Moura Dubeux Engenharia had R$129.3m of debt in March 2021, down from R$231.5m, one year before. However, because it has a cash reserve of R$113.4m, its net debt is less, at about R$15.9m.

How Strong Is Moura Dubeux Engenharia's Balance Sheet?

According to the last reported balance sheet, Moura Dubeux Engenharia had liabilities of R$450.7m due within 12 months, and liabilities of R$711.6m due beyond 12 months. Offsetting these obligations, it had cash of R$113.4m as well as receivables valued at R$215.8m due within 12 months. So it has liabilities totalling R$833.0m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's R$731.9m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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

Moura Dubeux Engenharia has net debt of just 1.4 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. It is just as well that Moura Dubeux Engenharia's load is not too heavy, because its EBIT was down 75% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Moura Dubeux Engenharia's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last two years, Moura Dubeux Engenharia 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

We feel some trepidation about Moura Dubeux Engenharia's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Moura Dubeux Engenharia's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. While Moura Dubeux Engenharia didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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