Here's Why EcoRodovias Infraestrutura e Logística (BVMF:ECOR3) Has A Meaningful Debt Burden

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. As with many other companies EcoRodovias Infraestrutura e Logística S.A. (BVMF:ECOR3) makes use of debt. But the more important question is: how much risk is that debt creating?

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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for EcoRodovias Infraestrutura e Logística

What Is EcoRodovias Infraestrutura e Logística's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 EcoRodovias Infraestrutura e Logística had debt of R$20.0b, up from R$16.0b in one year. However, because it has a cash reserve of R$4.64b, its net debt is less, at about R$15.3b.

A Look At EcoRodovias Infraestrutura e Logística's Liabilities

The latest balance sheet data shows that EcoRodovias Infraestrutura e Logística had liabilities of R$6.73b due within a year, and liabilities of R$18.3b falling due after that. Offsetting this, it had R$4.64b in cash and R$843.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$19.5b.

The deficiency here weighs heavily on the R$4.64b 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'd watch its balance sheet closely, without a doubt. At the end of the day, EcoRodovias Infraestrutura e Logística would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

EcoRodovias Infraestrutura e Logística has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 3.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. On a lighter note, we note that EcoRodovias Infraestrutura e Logística grew its EBIT by 28% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. There's no doubt that we learn most about debt from the balance sheet. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, EcoRodovias Infraestrutura e Logística saw substantial negative free cash flow, in total. 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

On the face of it, EcoRodovias Infraestrutura e Logística's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that EcoRodovias Infraestrutura e Logística is in the Infrastructure industry, which is often considered to be quite defensive. We're quite clear that we consider EcoRodovias Infraestrutura e Logística to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for EcoRodovias Infraestrutura e Logística you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.