EcoRodovias Infraestrutura e Logística (BVMF:ECOR3) Has A Somewhat Strained Balance Sheet

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. Importantly, EcoRodovias Infraestrutura e Logística S.A. (BVMF:ECOR3) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

Check out our latest analysis for EcoRodovias Infraestrutura e Logística

How Much Debt Does EcoRodovias Infraestrutura e Logística Carry?

The image below, which you can click on for greater detail, shows that EcoRodovias Infraestrutura e Logística had debt of R$9.14b at the end of September 2020, a reduction from R$9.67b over a year. However, because it has a cash reserve of R$2.15b, its net debt is less, at about R$6.98b.

How Healthy Is EcoRodovias Infraestrutura e Logística's Balance Sheet?

According to the last reported balance sheet, EcoRodovias Infraestrutura e Logística had liabilities of R$2.34b due within 12 months, and liabilities of R$9.37b due beyond 12 months. On the other hand, it had cash of R$2.15b and R$302.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$9.25b.

Given this deficit is actually higher than the company's market capitalization of R$7.22b, we think shareholders really should watch EcoRodovias Infraestrutura e Logística's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

EcoRodovias Infraestrutura e Logística's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 4.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The silver lining is that EcoRodovias Infraestrutura e Logística grew its EBIT by 154% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if EcoRodovias Infraestrutura e Logística 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, EcoRodovias Infraestrutura e Logística's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Neither EcoRodovias Infraestrutura e Logística's ability to handle its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. It's also worth noting that EcoRodovias Infraestrutura e Logística is in the Infrastructure industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think EcoRodovias Infraestrutura e Logística's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should be aware of the 1 warning sign we've spotted with EcoRodovias Infraestrutura e Logística .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you decide to trade EcoRodovias Infraestrutura e Logística, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.