Is Lojas Renner (BVMF:LREN3) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Lojas Renner S.A. (BVMF:LREN3) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lojas Renner

What Is Lojas Renner's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Lojas Renner had debt of R$3.37b, up from R$3.03b in one year. But on the other hand it also has R$5.79b in cash, leading to a R$2.42b net cash position.

How Strong Is Lojas Renner's Balance Sheet?

According to the last reported balance sheet, Lojas Renner had liabilities of R$5.41b due within 12 months, and liabilities of R$4.56b due beyond 12 months. Offsetting these obligations, it had cash of R$5.79b as well as receivables valued at R$4.81b due within 12 months. So it can boast R$637.9m more liquid assets than total liabilities.

This surplus suggests that Lojas Renner has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Lojas Renner has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Lojas Renner's EBIT fell a jaw-dropping 27% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Lojas Renner can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Lojas Renner 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. Looking at the most recent three years, Lojas Renner recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Lojas Renner has R$2.42b in net cash and a decent-looking balance sheet. So while Lojas Renner does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Lojas Renner has 5 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.