ENCE Energía y Celulosa (BME:ENC) Has A Pretty 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.' 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 can see that ENCE Energía y Celulosa, S.A. (BME:ENC) does use debt in its business. 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. 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.

See our latest analysis for ENCE Energía y Celulosa

What Is ENCE Energía y Celulosa's Net Debt?

You can click the graphic below for the historical numbers, but it shows that ENCE Energía y Celulosa had €385.6m of debt in June 2022, down from €520.4m, one year before. But it also has €428.2m in cash to offset that, meaning it has €42.5m net cash.

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

The latest balance sheet data shows that ENCE Energía y Celulosa had liabilities of €467.8m due within a year, and liabilities of €494.2m falling due after that. Offsetting these obligations, it had cash of €428.2m as well as receivables valued at €120.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €413.1m.

This deficit isn't so bad because ENCE Energía y Celulosa is worth €757.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, ENCE Energía y Celulosa boasts net cash, so it's fair to say it does not have a heavy debt load!

Although ENCE Energía y Celulosa made a loss at the EBIT level, last year, it was also good to see that it generated €109m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ENCE Energía y Celulosa's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While ENCE Energía y Celulosa does have more liabilities than liquid assets, it also has net cash of €42.5m. And it impressed us with free cash flow of €220m, being 202% of its EBIT. So we are not troubled with ENCE Energía y Celulosa's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for ENCE Energía y Celulosa (1 makes us a bit uncomfortable) you should be aware of.

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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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.