Does C&A Modas (BVMF:CEAB3) Have A Healthy Balance Sheet?

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.' 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 C&A Modas S.A. (BVMF:CEAB3) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for C&A Modas

How Much Debt Does C&A Modas Carry?

The image below, which you can click on for greater detail, shows that at September 2020 C&A Modas had debt of R$1.22b, up from none in one year. However, its balance sheet shows it holds R$1.32b in cash, so it actually has R$102.4m net cash.

A Look At C&A Modas' Liabilities

The latest balance sheet data shows that C&A Modas had liabilities of R$1.83b due within a year, and liabilities of R$2.40b falling due after that. On the other hand, it had cash of R$1.32b and R$970.9m worth of receivables due within a year. So it has liabilities totalling R$1.94b more than its cash and near-term receivables, combined.

C&A Modas has a market capitalization of R$3.82b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, C&A Modas also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, C&A Modas grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. 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 C&A Modas'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. C&A Modas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, C&A Modas recorded free cash flow worth 68% 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.

Summing up

While C&A Modas does have more liabilities than liquid assets, it also has net cash of R$102.4m. And it impressed us with its EBIT growth of 56% over the last year. So we don't have any problem with C&A Modas's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with C&A Modas (including 1 which doesn't sit too well with us) .

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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