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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that EcoRodovias Infraestrutura e Logística S.A. (BVMF:ECOR3) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for EcoRodovias Infraestrutura e Logística

What Is EcoRodovias Infraestrutura e Logística's Net Debt?

As you can see below, at the end of June 2023, EcoRodovias Infraestrutura e Logística had R$14.2b of debt, up from R$10.0b a year ago. Click the image for more detail. However, it does have R$2.10b in cash offsetting this, leading to net debt of about R$12.1b.

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

The latest balance sheet data shows that EcoRodovias Infraestrutura e Logística had liabilities of R$4.89b due within a year, and liabilities of R$13.7b falling due after that. Offsetting these obligations, it had cash of R$2.10b as well as receivables valued at R$669.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$15.9b.

The deficiency here weighs heavily on the R$5.23b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, EcoRodovias Infraestrutura e Logística would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

EcoRodovias Infraestrutura e Logística's debt is 4.2 times its EBITDA, and its EBIT cover its interest expense 2.7 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 good news is that EcoRodovias Infraestrutura e Logística grew its EBIT a smooth 61% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine EcoRodovias Infraestrutura e Logística's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, EcoRodovias Infraestrutura e Logística burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both EcoRodovias Infraestrutura e Logística's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Infrastructure industry companies like EcoRodovias Infraestrutura e Logística commonly do use debt without problems. Overall, it seems to us that EcoRodovias Infraestrutura e Logística's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 1 warning sign for EcoRodovias Infraestrutura e Logística you should be aware of.

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.