Is Lojas Renner (BVMF:LREN3) Using Too Much Debt?

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 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. We can see that Lojas Renner S.A. (BVMF:LREN3) does use debt in its business. But is this debt a concern to shareholders?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Lojas Renner

How Much Debt Does Lojas Renner Carry?

The image below, which you can click on for greater detail, shows that Lojas Renner had debt of R$2.16b at the end of September 2023, a reduction from R$3.41b over a year. But on the other hand it also has R$3.27b in cash, leading to a R$1.11b net cash position.

A Look At Lojas Renner's Liabilities

Zooming in on the latest balance sheet data, we can see that Lojas Renner had liabilities of R$6.90b due within 12 months and liabilities of R$3.29b due beyond that. Offsetting these obligations, it had cash of R$3.27b as well as receivables valued at R$6.28b due within 12 months. So it has liabilities totalling R$642.3m more than its cash and near-term receivables, combined.

Since publicly traded Lojas Renner shares are worth a total of R$14.2b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Lojas Renner also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Lojas Renner's load is not too heavy, because its EBIT was down 27% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Lojas Renner's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Lojas Renner generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Lojas Renner has R$1.11b in net cash. And it impressed us with free cash flow of R$1.3b, being 100% of its EBIT. So we are not troubled with Lojas Renner'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, we've discovered 1 warning sign for Lojas Renner that you should be aware of before investing here.

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.