Is Portuaria Cabo Froward (SNSE:FROWARD) A Risky Investment?

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.' 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 note that Portuaria Cabo Froward S.A. (SNSE:FROWARD) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Portuaria Cabo Froward

How Much Debt Does Portuaria Cabo Froward Carry?

The image below, which you can click on for greater detail, shows that Portuaria Cabo Froward had debt of US$11.1m at the end of December 2020, a reduction from US$14.8m over a year. On the flip side, it has US$1.58m in cash leading to net debt of about US$9.50m.

A Look At Portuaria Cabo Froward's Liabilities

We can see from the most recent balance sheet that Portuaria Cabo Froward had liabilities of US$12.7m falling due within a year, and liabilities of US$23.2m due beyond that. Offsetting this, it had US$1.58m in cash and US$10.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$23.9m.

Portuaria Cabo Froward has a market capitalization of US$73.4m, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Portuaria Cabo Froward's net debt is only 0.56 times its EBITDA. And its EBIT covers its interest expense a whopping 21.2 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Portuaria Cabo Froward's saving grace is its low debt levels, because its EBIT has tanked 36% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Portuaria Cabo Froward will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. In the last three years, Portuaria Cabo Froward's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Portuaria Cabo Froward's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. We would also note that Infrastructure industry companies like Portuaria Cabo Froward commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Portuaria Cabo Froward's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 2 warning signs for Portuaria Cabo Froward you should know about.

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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