Here's Why Localiza Rent a Car (BVMF:RENT3) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Localiza Rent a Car S.A. (BVMF:RENT3) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Localiza Rent a Car

What Is Localiza Rent a Car's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Localiza Rent a Car had R$44.1b of debt, an increase on R$37.5b, over one year. On the flip side, it has R$11.4b in cash leading to net debt of about R$32.7b.

A Look At Localiza Rent a Car's Liabilities

We can see from the most recent balance sheet that Localiza Rent a Car had liabilities of R$16.4b falling due within a year, and liabilities of R$39.3b due beyond that. On the other hand, it had cash of R$11.4b and R$4.83b worth of receivables due within a year. So it has liabilities totalling R$39.5b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of R$45.0b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Localiza Rent a Car shareholders face the double whammy of a high net debt to EBITDA ratio (6.0), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. The debt burden here is substantial. Fortunately, Localiza Rent a Car grew its EBIT by 3.6% in the last year, slowly shrinking its debt relative to earnings. 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 Localiza Rent a Car'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 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, Localiza Rent a Car saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Localiza Rent a Car's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Localiza Rent a Car'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. 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. For instance, we've identified 3 warning signs for Localiza Rent a Car (2 don't sit too well with us) 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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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.