Companhia CELG de Participações S/A (BVMF:GPAR3) Could Easily Take On More Debt

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 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. As with many other companies Companhia CELG de Participações S/A (BVMF:GPAR3) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Companhia CELG de Participações S/A

What Is Companhia CELG de Participações S/A's Net Debt?

As you can see below, Companhia CELG de Participações S/A had R$101.1m of debt at June 2021, down from R$109.7m a year prior. However, it does have R$205.6m in cash offsetting this, leading to net cash of R$104.5m.

How Strong Is Companhia CELG de Participações S/A's Balance Sheet?

The latest balance sheet data shows that Companhia CELG de Participações S/A had liabilities of R$116.2m due within a year, and liabilities of R$469.1m falling due after that. Offsetting these obligations, it had cash of R$205.6m as well as receivables valued at R$218.8m due within 12 months. So its liabilities total R$160.9m more than the combination of its cash and short-term receivables.

Given Companhia CELG de Participações S/A has a market capitalization of R$5.07b, it's hard to believe these liabilities pose much threat. 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, Companhia CELG de Participações S/A also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Companhia CELG de Participações S/A grew its EBIT by 199% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Companhia CELG de Participações S/A's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Companhia CELG de Participações S/A has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Companhia CELG de Participações S/A recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about Companhia CELG de Participações S/A's liabilities, but we can be reassured by the fact it has has net cash of R$104.5m. And we liked the look of last year's 199% year-on-year EBIT growth. So is Companhia CELG de Participações S/A's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Companhia CELG de Participações S/A you should know about.

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.

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.

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