StoneCo (NASDAQ:STNE) Seems To Use Debt Quite Sensibly

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 StoneCo Ltd. (NASDAQ:STNE) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for StoneCo

How Much Debt Does StoneCo Carry?

The image below, which you can click on for greater detail, shows that StoneCo had debt of R$6.54b at the end of June 2022, a reduction from R$8.67b over a year. But it also has R$9.13b in cash to offset that, meaning it has R$2.59b net cash.

How Strong Is StoneCo's Balance Sheet?

The latest balance sheet data shows that StoneCo had liabilities of R$22.1b due within a year, and liabilities of R$4.78b falling due after that. Offsetting this, it had R$9.13b in cash and R$18.4b in receivables that were due within 12 months. So it can boast R$643.4m 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!

Notably, StoneCo's EBIT launched higher than Elon Musk, gaining a whopping 109% on last year. There's no doubt that we learn most about debt from the balance sheet. 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. In the last three years, StoneCo's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that StoneCo has net cash of R$2.59b, as well as more liquid assets than liabilities. And we liked the look of last year's 109% year-on-year EBIT growth. So we don't have any problem with StoneCo's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with StoneCo , 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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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.