We Think Impresa - Sociedade Gestora de Participações Sociais (ELI:IPR) Is Taking Some Risk With Its 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.' 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. We can see that Impresa - Sociedade Gestora de Participações Sociais, S.A. (ELI:IPR) does use debt in its business. But the real question is whether this debt is making the company risky.

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See 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 €154.4m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has €25.2m in cash leading to net debt of about €129.2m.

How Healthy 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 €135.2m falling due within a year, and liabilities of €108.4m due beyond that. Offsetting these obligations, it had cash of €25.2m as well as receivables valued at €31.2m due within 12 months. So its liabilities total €187.3m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the €40.3m 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. After all, Impresa - Sociedade Gestora de Participações Sociais would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Impresa - Sociedade Gestora de Participações Sociais has a debt to EBITDA ratio of 4.6 and its EBIT covered its interest expense 4.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably Impresa - Sociedade Gestora de Participações Sociais's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But it is Impresa - Sociedade Gestora de Participações Sociais's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Mulling over Impresa - Sociedade Gestora de Participações Sociais's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Impresa - Sociedade Gestora de Participações Sociais stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should learn about the 2 warning signs we've spotted with Impresa - Sociedade Gestora de Participações Sociais (including 1 which is significant) .

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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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.