These 4 Measures Indicate That EcoRodovias Infraestrutura e Logística (BVMF:ECOR3) Is Using Debt Extensively

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.' 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 the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for EcoRodovias Infraestrutura e Logística

What Is EcoRodovias Infraestrutura e Logística's Debt?

As you can see below, EcoRodovias Infraestrutura e Logística had R$8.46b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of R$1.39b, its net debt is less, at about R$7.06b.

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

Zooming in on the latest balance sheet data, we can see that EcoRodovias Infraestrutura e Logística had liabilities of R$2.52b due within 12 months and liabilities of R$8.52b due beyond that. Offsetting this, it had R$1.39b in cash and R$280.1m in receivables that were due within 12 months. So its liabilities total R$9.36b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's R$6.56b market capitalization, you might well be inclined to review the balance sheet intently. 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). 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 3.9 and its EBIT covered its interest expense 3.2 times. 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 improved its EBIT by 3.3% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. 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 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's not great, when it comes to paying down debt.

Our View

Mulling over EcoRodovias Infraestrutura e Logística's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. It's also worth noting that EcoRodovias Infraestrutura e Logística is in the Infrastructure industry, which is often considered to be quite defensive. Overall, we think it's fair to say that EcoRodovias Infraestrutura e Logística has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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