Here's Why Embpar Participacoes (BVMF:EPAR3) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Embpar Participacoes S.A. (BVMF:EPAR3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Embpar Participacoes

What Is Embpar Participacoes's Debt?

As you can see below, Embpar Participacoes had R$26.2m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has R$30.1m in cash to offset that, meaning it has R$3.94m net cash.

How Healthy Is Embpar Participacoes' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Embpar Participacoes had liabilities of R$89.4m due within 12 months and liabilities of R$68.1m due beyond that. Offsetting these obligations, it had cash of R$30.1m as well as receivables valued at R$46.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$81.1m.

This deficit isn't so bad because Embpar Participacoes is worth R$249.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Embpar Participacoes boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Embpar Participacoes grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Embpar Participacoes's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Embpar Participacoes 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. Looking at the most recent three years, Embpar Participacoes recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

Although Embpar Participacoes's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$3.94m. And we liked the look of last year's 97% year-on-year EBIT growth. So we are not troubled with Embpar Participacoes's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Embpar Participacoes has 6 warning signs (and 2 which don't sit too well with us) we think you should know about.

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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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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