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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. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Natura & Co Holding SA (BVMF: NTCO3) uses debt. But should shareholders be concerned about its use of debt?
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company can’t 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. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for Natura & Co Holding
What is Natura & Co Holding’s debt?
The image below, which you can click for more details, shows that Natura & Co Holding had a debt of R $ 14.1 billion at the end of June 2021, down from R $ 20.7 billion over one year. . However, he has 7.99 billion reais in cash offsetting this, which leads to a net debt of around 6.15 billion reais.
A look at the liabilities of Natura & Co Holding
Zooming in on the latest balance sheet data, we can see that Natura & Co Holding had R $ 14.5 billion in liabilities due within 12 months and R $ 17.8 billion in liabilities due beyond. On the other hand, he had cash of 7.99 billion reais and 5.16 billion reais in debts due within one year. Thus, its liabilities total 19.1 billion reais more than the combination of its cash and short-term receivables.
Natura & Co Holding has a very large market capitalization of R $ 73.0 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.
While Natura & Co Holding has a very reasonable net debt to EBITDA ratio of 2.1, its interest coverage appears low at 1.9. This suggests that the company is paying fairly high interest rates. Either way, there’s no doubt that the stock uses significant leverage. Notably, Natura & Co Holding’s EBIT was higher than Elon Musk’s, gaining a whopping 171% from last year. The balance sheet is clearly the area you need to focus on when analyzing debt. But in the end, the future profitability of the company will decide whether Natura & Co Holding can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Taking into account the last three years, Natura & Co Holding has effectively recorded a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.
Our point of view
The coverage of Natura & Co Holding’s interests and the conversion of EBIT into free cash flow certainly weighs on this, in our opinion. But the good news is that he seems to be able to increase his EBIT with ease. We think Natura & Co Holding’s debt makes it a bit risky, after considering the aforementioned data points together. Not all risks are bad, as they can increase stock price returns if they are profitable, but this risk of leverage is worth keeping in mind. 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. We have identified 3 warning signs with Natura & Co Holding (at least 1 which is a bit worrying), and understanding them should be part of your investment process.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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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 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 the mentioned stocks.
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