These 4 Measures Indicate That Lojas Renner (BVMF:LREN3) Is Using Debt Reasonably Well

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. As with many other companies Lojas Renner S.A. (BVMF:LREN3) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out 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$2.33b at the end of June 2023, a reduction from R$3.44b over a year. However, its balance sheet shows it holds R$2.90b in cash, so it actually has R$574.9m net cash.

How Healthy Is Lojas Renner's Balance Sheet?

We can see from the most recent balance sheet that Lojas Renner had liabilities of R$6.84b falling due within a year, and liabilities of R$3.41b due beyond that. Offsetting these obligations, it had cash of R$2.90b as well as receivables valued at R$6.85b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$491.4m.

Given Lojas Renner has a market capitalization of R$18.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Lojas Renner boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Lojas Renner has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Lojas Renner 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 two years, Lojas Renner recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Lojas Renner's liabilities, but we can be reassured by the fact it has has net cash of R$574.9m. And it impressed us with free cash flow of R$694m, being 75% of its EBIT. So we don't have any problem with Lojas Renner'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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Lojas Renner 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.