Down Debt

Here’s why São Carlos Empreendimentos e Participações (BVMF:SCAR3) is weighed down by its debt

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that São Carlos Empreendimentos e Participações SA (BVMF:SCAR3) uses debt in its business. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

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What is the net debt of São Carlos Empreendimentos e Participações?

The image below, which you can click on for more details, shows that in June 2022, São Carlos Empreendimentos e Participações had a debt of R$1.89 billion, compared to R$1.35 billion in a year. Net debt is about the same, since she doesn’t have a lot of cash.

BOVESPA:SCAR3 Debt to equity October 28, 2022

How strong is the balance sheet of São Carlos Empreendimentos e Participações?

Zooming in on the latest balance sheet data, we can see that São Carlos Empreendimentos e Participações had liabilities of R$283.4 million due within 12 months and liabilities of R$1.67 billion due beyond. On the other hand, it had cash of R$7.48 million and R$53.7 million in receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 1.89 billion reais.

Since this deficit is actually greater than the company’s market capitalization of 1.52 billion reais, we believe that shareholders should really monitor the level of debt of São Carlos Empreendimentos e Participações, like a parent watching her child riding a bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

The shareholders of São Carlos Empreendimentos e Participações face the double whammy of a high net debt to EBITDA ratio (10.3) and a rather low interest coverage, since the EBIT is only 0.90 times the interest charge. This means that we would consider him to be heavily indebted. Investors should also be troubled by the fact that São Carlos Empreendimentos e Participações has seen its EBIT fall by 17% in the last twelve months. If this is how things continue, managing the debt burden will be like delivering hot coffees on a pogo stick. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether São Carlos Empreendimentos e Participações can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, São Carlos Empreendimentos e Participações’ free cash flow has amounted to 35% of its EBIT, less than expected. This low cash conversion makes debt management more difficult.

Our point of view

To be frank, São Carlos Empreendimentos e Participações’ net debt to EBITDA and its history of covering its interest expense with its EBIT makes us rather uncomfortable with its debt levels. That said, its ability to convert EBIT to free cash flow isn’t all that worrying. After reviewing the data points discussed, we believe that São Carlos Empreendimentos e Participações has too much debt. That kind of risk is acceptable to some, but it certainly doesn’t float our boat. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that São Carlos Empreendimentos e Participações displays 2 warning signs in our investment analysis you should know…

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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Find out if São Carlos Empreendimentos e Participações is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.