We Think Impresa - Sociedade Gestora de Participações Sociais (ELI:IPR) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Impresa - Sociedade Gestora de Participações Sociais, S.A. (ELI:IPR) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

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

You can click the graphic below for the historical numbers, but it shows that Impresa - Sociedade Gestora de Participações Sociais had €162.7m of debt in June 2020, down from €170.5m, one year before. And it doesn't have much cash, so its net debt is about the same.

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

According to the last reported balance sheet, Impresa - Sociedade Gestora de Participações Sociais had liabilities of €99.8m due within 12 months, and liabilities of €141.6m due beyond 12 months. Offsetting this, it had €2.54m in cash and €25.6m in receivables that were due within 12 months. So it has liabilities totalling €213.2m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €21.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 8.5 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 a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. 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 Impresa - Sociedade Gestora de Participações Sociais can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Impresa - Sociedade Gestora de Participações Sociais actually produced more free cash flow than EBIT. 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 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. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Impresa - Sociedade Gestora de Participações Sociais (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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