Here's Why Santos Brasil Participações (BVMF:STBP3) 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. We note that Santos Brasil Participações S.A. (BVMF:STBP3) 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 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Santos Brasil Participações

What Is Santos Brasil Participações's Net Debt?

The chart below, which you can click on for greater detail, shows that Santos Brasil Participações had R$433.2m in debt in December 2020; about the same as the year before. However, it does have R$1.07b in cash offsetting this, leading to net cash of R$637.3m.

How Strong Is Santos Brasil Participações' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Santos Brasil Participações had liabilities of R$296.4m due within 12 months and liabilities of R$1.84b due beyond that. Offsetting this, it had R$1.07b in cash and R$135.0m in receivables that were due within 12 months. So it has liabilities totalling R$926.6m more than its cash and near-term receivables, combined.

Of course, Santos Brasil Participações has a market capitalization of R$5.86b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Santos Brasil Participações also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Santos Brasil Participações's EBIT fell a jaw-dropping 45% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Santos Brasil Participações'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Santos Brasil Participações may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Santos Brasil Participações 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.

Summing up

While Santos Brasil Participações does have more liabilities than liquid assets, it also has net cash of R$637.3m. Despite its cash we think that Santos Brasil Participações seems to struggle to grow its EBIT, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Santos Brasil Participações you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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