Does ENCE Energía y Celulosa (BME:ENC) Have A Healthy Balance Sheet?

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 ENCE Energía y Celulosa, S.A. (BME:ENC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for ENCE Energía y Celulosa

What Is ENCE Energía y Celulosa's Net Debt?

The image below, which you can click on for greater detail, shows that ENCE Energía y Celulosa had debt of €406.9m at the end of September 2022, a reduction from €533.8m over a year. However, its balance sheet shows it holds €470.6m in cash, so it actually has €63.7m net cash.

How Healthy Is ENCE Energía y Celulosa's Balance Sheet?

The latest balance sheet data shows that ENCE Energía y Celulosa had liabilities of €519.6m due within a year, and liabilities of €473.8m falling due after that. Offsetting this, it had €470.6m in cash and €94.5m in receivables that were due within 12 months. So its liabilities total €428.3m more than the combination of its cash and short-term receivables.

ENCE Energía y Celulosa has a market capitalization of €722.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, ENCE Energía y Celulosa also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that ENCE Energía y Celulosa grew its EBIT by 152% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ENCE Energía y Celulosa can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. ENCE Energía y Celulosa 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. Happily for any shareholders, ENCE Energía y Celulosa actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although ENCE Energía y Celulosa's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €63.7m. And it impressed us with free cash flow of €317m, being 244% of its EBIT. So we don't think ENCE Energía y Celulosa's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that ENCE Energía y Celulosa is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.