We Think Embpar Participacoes (BVMF:EPAR3) Can Stay On Top Of Its Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Embpar Participacoes S.A. (BVMF:EPAR3) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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, at the end of December 2021, Embpar Participacoes had R$55.5m of debt, up from R$29.7m a year ago. Click the image for more detail. However, its balance sheet shows it holds R$59.5m in cash, so it actually has R$3.96m net cash.

How Healthy Is Embpar Participacoes' Balance Sheet?

The latest balance sheet data shows that Embpar Participacoes had liabilities of R$93.7m due within a year, and liabilities of R$74.4m falling due after that. On the other hand, it had cash of R$59.5m and R$73.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$35.2m.

Since publicly traded Embpar Participacoes shares are worth a total of R$289.6m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Embpar Participacoes boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Embpar Participacoes grew its EBIT by 162% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Embpar Participacoes has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Embpar Participacoes basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing up

While Embpar Participacoes does have more liabilities than liquid assets, it also has net cash of R$3.96m. And it impressed us with its EBIT growth of 162% over the last year. So we don't have any problem with Embpar Participacoes's use of 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Embpar Participacoes (of which 1 is concerning!) you should know about.

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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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.