Does Impresa - Sociedade Gestora de Participações Sociais (ELI:IPR) Have A Healthy Balance Sheet?

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 Impresa - Sociedade Gestora de Participações Sociais, S.A. (ELI:IPR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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 Impresa - Sociedade Gestora de Participações Sociais

What Is Impresa - Sociedade Gestora de Participações Sociais's Debt?

As you can see below, Impresa - Sociedade Gestora de Participações Sociais had €152.7m of debt at December 2020, down from €159.9m a year prior. On the flip side, it has €8.67m in cash leading to net debt of about €144.0m.

How Strong Is Impresa - Sociedade Gestora de Participações Sociais' Balance Sheet?

We can see from the most recent balance sheet that Impresa - Sociedade Gestora de Participações Sociais had liabilities of €105.5m falling due within a year, and liabilities of €141.6m due beyond that. On the other hand, it had cash of €8.67m and €32.5m worth of receivables due within a year. So its liabilities total €206.0m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €31.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Impresa - Sociedade Gestora de Participações Sociais would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Impresa - Sociedade Gestora de Participações Sociais has a rather high debt to EBITDA ratio of 5.1 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.2 times, suggesting it can responsibly service its obligations. The good news is that Impresa - Sociedade Gestora de Participações Sociais grew its EBIT a smooth 33% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Impresa - Sociedade Gestora de Participações Sociais 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Impresa - Sociedade Gestora de Participações Sociais generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

We feel some trepidation about Impresa - Sociedade Gestora de Participações Sociais's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Impresa - Sociedade Gestora de Participações Sociais 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. To that end, you should learn about the 3 warning signs we've spotted with Impresa - Sociedade Gestora de Participações Sociais (including 1 which makes us a bit uncomfortable) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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