Impresa - Sociedade Gestora de Participações Sociais (ELI:IPR) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Impresa - Sociedade Gestora de Participações Sociais, S.A. (ELI:IPR) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Impresa - Sociedade Gestora de Participações Sociais

How Much Debt Does Impresa - Sociedade Gestora de Participações Sociais Carry?

The image below, which you can click on for greater detail, shows that Impresa - Sociedade Gestora de Participações Sociais had debt of €162.7m at the end of June 2020, a reduction from €170.5m over a year. Net debt is about the same, since the it doesn't have much cash.

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

Zooming in on the latest balance sheet data, we can see that Impresa - Sociedade Gestora de Participações Sociais had liabilities of €99.8m due within 12 months and liabilities of €141.6m due beyond that. Offsetting this, it had €2.54m in cash and €28.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €210.2m.

This deficit casts a shadow over the €22.3m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Impresa - Sociedade Gestora de Participações Sociais would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 8.2 hit our confidence in Impresa - Sociedade Gestora de Participações Sociais like a one-two punch to the gut. The debt burden here is substantial. The good news is that Impresa - Sociedade Gestora de Participações Sociais grew its EBIT a smooth 34% 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

While Impresa - Sociedade Gestora de Participações Sociais'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. Taking the abovementioned factors together we do think Impresa - Sociedade Gestora de Participações Sociais's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Impresa - Sociedade Gestora de Participações Sociais (of which 2 are potentially serious!) 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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