Is StoneCo (NASDAQ:STNE) A Risky Investment?

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. Importantly, StoneCo Ltd. (NASDAQ:STNE) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for StoneCo

How Much Debt Does StoneCo Carry?

The image below, which you can click on for greater detail, shows that at December 2021 StoneCo had debt of R$8.09b, up from R$5.91b in one year. But on the other hand it also has R$8.84b in cash, leading to a R$746.2m net cash position.

A Look At StoneCo's Liabilities

We can see from the most recent balance sheet that StoneCo had liabilities of R$22.8b falling due within a year, and liabilities of R$5.67b due beyond that. Offsetting these obligations, it had cash of R$8.84b as well as receivables valued at R$20.3b due within 12 months. So it can boast R$659.3m more liquid assets than total liabilities.

This short term liquidity is a sign that StoneCo could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, StoneCo boasts net cash, so it's fair to say it does not have a heavy debt load!

The bad news is that StoneCo saw its EBIT decline by 19% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine StoneCo's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. StoneCo may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, StoneCo burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case StoneCo has R$746.2m in net cash and a decent-looking balance sheet. Despite its cash we think that StoneCo seems to struggle to convert EBIT to free cash flow, so we are wary of the stock. 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. For example, we've discovered 1 warning sign for StoneCo that you should be aware of before investing here.

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.