Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies BR Malls Participações SA (BVMF: BRML3) uses debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest review for BR Malls Participações
How much debt do BR Malls Participações carry?
As you can see below, at the end of June 2021, BR Malls Participações had a debt of R $ 4.23 billion, up from R $ 3.41 billion a year ago. Click on the image for more details. And he doesn’t have a lot of cash, so his net debt is about the same.
How strong is BR Malls Participações’ balance sheet?
The latest balance sheet data shows that BR Malls Participações had liabilities of R $ 878.4 million due within one year, and liabilities of R $ 7.38 billion due after that. On the other hand, he had cash of 17.8 million reais and 379.1 million reais in debts due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by 7.86 billion reais.
Given that this deficit is actually greater than the company’s market cap of R $ 6.91 billion, we believe shareholders should really watch BR Malls Participações debt levels, like a parent watching their child riding a bike for the first time. Hypothetically, an extremely large dilution would be required if the company was forced to repay its debts by raising capital at the current share price.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
BR Malls Participações shareholders are faced with the double whammy of a high net debt / EBITDA ratio (7.4) and relatively low interest coverage, since EBIT is only 2.1 times the interest charges. The debt burden here is considerable. Worse yet, BR Malls Participações has seen its EBIT reach 36% over the past 12 months. If the income continues like this for the long term, there is an incredible chance to pay off that debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine BR Malls Participações’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, BR Malls Participações has generated strong free cash flow equivalent to 68% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
To be frank, BR Malls Participações’ net debt to EBITDA and track record of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, it seems to us that the balance sheet of BR Malls Participações is really very risky for the company. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for BR Malls Participações that you need to be aware of.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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