Inapa - Investimentos Participações e Gestão (ELI:INA) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Inapa - Investimentos, Participações e Gestão, S.A. (ELI:INA) 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 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Inapa - Investimentos Participações e Gestão

How Much Debt Does Inapa - Investimentos Participações e Gestão Carry?

As you can see below, Inapa - Investimentos Participações e Gestão had €253.9m of debt at June 2022, down from €284.5m a year prior. On the flip side, it has €27.5m in cash leading to net debt of about €226.4m.

How Strong Is Inapa - Investimentos Participações e Gestão's Balance Sheet?

According to the last reported balance sheet, Inapa - Investimentos Participações e Gestão had liabilities of €291.5m due within 12 months, and liabilities of €240.3m due beyond 12 months. Offsetting this, it had €27.5m in cash and €76.3m in receivables that were due within 12 months. So its liabilities total €428.0m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €12.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Inapa - Investimentos Participações e Gestão would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Inapa - Investimentos Participações e Gestão's debt is 5.0 times its EBITDA, and its EBIT cover its interest expense 3.9 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, it should be some comfort for shareholders to recall that Inapa - Investimentos Participações e Gestão actually grew its EBIT by a hefty 309%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Inapa - Investimentos Participações e Gestão will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Inapa - Investimentos Participações e Gestão actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

While Inapa - Investimentos Participações e Gestão's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. When we consider all the factors discussed, it seems to us that Inapa - Investimentos Participações e Gestão is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Inapa - Investimentos Participações e Gestão has 3 warning signs (and 1 which is significant) we think you should know about.

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.