Is Multiplan Empreendimentos Imobiliários (BVMF:MULT3) A Risky Investment?

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.' 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 Multiplan Empreendimentos Imobiliários S.A. (BVMF:MULT3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Multiplan Empreendimentos Imobiliários

What Is Multiplan Empreendimentos Imobiliários's Debt?

You can click the graphic below for the historical numbers, but it shows that Multiplan Empreendimentos Imobiliários had R$3.12b of debt in March 2021, down from R$3.35b, one year before. On the flip side, it has R$1.18b in cash leading to net debt of about R$1.94b.

A Look At Multiplan Empreendimentos Imobiliários' Liabilities

The latest balance sheet data shows that Multiplan Empreendimentos Imobiliários had liabilities of R$1.19b due within a year, and liabilities of R$3.05b falling due after that. On the other hand, it had cash of R$1.18b and R$501.5m worth of receivables due within a year. So it has liabilities totalling R$2.56b more than its cash and near-term receivables, combined.

Since publicly traded Multiplan Empreendimentos Imobiliários shares are worth a total of R$14.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Multiplan Empreendimentos Imobiliários has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 4.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Worse, Multiplan Empreendimentos Imobiliários's EBIT was down 50% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Multiplan 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Multiplan Empreendimentos Imobiliários actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Neither Multiplan Empreendimentos Imobiliários's ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Multiplan Empreendimentos Imobiliários is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. To that end, you should learn about the 3 warning signs we've spotted with Multiplan Empreendimentos Imobiliários (including 1 which is significant) .

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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