Does São Martinho (BVMF: SMTO3) have a healthy balance sheet?
David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We notice that São Martinho SA (BVMF: SMTO3) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
See our latest analysis for São Martinho
What is São Martinho’s net debt?
The graph below, which you can click for more details, shows that São Martinho had a debt of 4.71 billion reais in September 2021; about the same as the year before. On the other hand, he has 1.36 billion reais in cash, resulting in a net debt of around 3.35 billion reais.
A look at São Martinho’s liabilities
According to the latest published balance sheet, São Martinho had a liability of R $ 2.19 billion maturing within 12 months and a liability of R $ 7.14 billion maturing beyond 12 months. In return, he had 1.36 billion reais in cash and 588.0 million reais in receivables due within 12 months. It therefore has liabilities totaling 7.39 billion reais more than its combined cash and short-term receivables.
While this may sound like a lot, it is not that big of a deal since São Martinho has a market capitalization of 12.4 billion reais, and could therefore likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
São Martinho has a low net debt to EBITDA ratio of just 1.1. And its EBIT easily covers its interest charges, being 16.4 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. And we also warmly note that São Martinho increased its EBIT by 16% last year, which makes its debt more manageable. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether São Martinho can strengthen its balance sheet over time. 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 pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, São Martinho has recorded free cash flow of 56% of its EBIT, which is close to normal, given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
São Martinho’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But frankly, we think his total passive level undermines that feeling a bit. All these things considered, it looks like São Martinho can comfortably manage their current debt levels. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 3 warning signs for São Martinho which you should know before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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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 any stock 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.