Is Empresas Tricot (SNSE:TRICOT) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Empresas Tricot S.A. (SNSE:TRICOT) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Empresas Tricot

What Is Empresas Tricot's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Empresas Tricot had CL$29.4b of debt in September 2020, down from CL$36.2b, one year before. However, its balance sheet shows it holds CL$63.3b in cash, so it actually has CL$34.0b net cash.

A Look At Empresas Tricot's Liabilities

The latest balance sheet data shows that Empresas Tricot had liabilities of CL$43.9b due within a year, and liabilities of CL$82.6b falling due after that. On the other hand, it had cash of CL$63.3b and CL$1.99b worth of receivables due within a year. So it has liabilities totalling CL$61.2b more than its cash and near-term receivables, combined.

Empresas Tricot has a market capitalization of CL$198.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Empresas Tricot also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Empresas Tricot's EBIT fell a jaw-dropping 88% 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 Empresas Tricot'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Empresas Tricot 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. Over the most recent three years, Empresas Tricot recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Empresas Tricot does have more liabilities than liquid assets, it also has net cash of CL$34.0b. And it impressed us with free cash flow of CL$39b, being 78% of its EBIT. So although we see some areas for improvement, we're not too worried about Empresas Tricot's balance sheet. 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. For instance, we've identified 1 warning sign for Empresas Tricot that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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