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. We note that EcoRodovias Infraestrutura e Logística S.A. (BVMF:ECOR3) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

The image below, which you can click on for greater detail, shows that at March 2023 EcoRodovias Infraestrutura e Logística had debt of R$12.4b, up from R$10.3b in one year. However, it does have R$2.06b in cash offsetting this, leading to net debt of about R$10.4b.

A Look At EcoRodovias Infraestrutura e Logística's Liabilities

The latest balance sheet data shows that EcoRodovias Infraestrutura e Logística had liabilities of R$3.65b due within a year, and liabilities of R$13.0b falling due after that. Offsetting these obligations, it had cash of R$2.06b as well as receivables valued at R$631.4m due within 12 months. So it has liabilities totalling R$14.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the R$4.83b 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. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. On the other hand, EcoRodovias Infraestrutura e Logística grew its EBIT by 27% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. 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'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. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, EcoRodovias Infraestrutura e Logística actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

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. 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. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. To that end, you should be aware of the 1 warning sign we've spotted with EcoRodovias Infraestrutura e Logística .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.