Portuaria Cabo Froward (SNSE:FROWARD) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Portuaria Cabo Froward S.A. (SNSE:FROWARD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Portuaria Cabo Froward

What Is Portuaria Cabo Froward's Net Debt?

The image below, which you can click on for greater detail, shows that Portuaria Cabo Froward had debt of US$12.6m at the end of September 2020, a reduction from US$16.3m over a year. However, it also had US$1.90m in cash, and so its net debt is US$10.7m.

How Healthy Is Portuaria Cabo Froward's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Portuaria Cabo Froward had liabilities of US$9.91m due within 12 months and liabilities of US$24.8m due beyond that. On the other hand, it had cash of US$1.90m and US$5.54m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$27.3m.

While this might seem like a lot, it is not so bad since Portuaria Cabo Froward has a market capitalization of US$73.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 0.57 times its EBITDA. And its EBIT covers its interest expense a whopping 19.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Portuaria Cabo Froward if management cannot prevent a repeat of the 29% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Portuaria Cabo Froward's earnings that will influence how the balance sheet holds up in the future. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Portuaria Cabo Froward's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Based on what we've seen Portuaria Cabo Froward is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. It's also worth noting that Portuaria Cabo Froward is in the Infrastructure industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Portuaria Cabo Froward's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. We've identified 2 warning signs with Portuaria Cabo Froward , and understanding them should be part of your investment process.

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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