Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Suzano S.A. (BVMF:SUZB3) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those 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. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Our analysis indicates that SUZB3 is potentially undervalued!
What is Suzano’s net debt?
You can click on the graph below for historical figures, but it shows that in June 2022, Suzano had a debt of R$75.2 billion, an increase from R$68.5 billion, on a year. However, as it has a cash reserve of R$20.0 billion, its net debt is less, at around R$55.2 billion.
How strong is Suzano’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Suzano had liabilities of R$12.1 billion due within 12 months and liabilities of R$86.4 billion due beyond. In return, he had R$20.0 billion in cash and R$6.29 billion in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 72.1 billion reais.
When you consider that this shortfall exceeds the company’s huge market capitalization of R$59.8 billion, you might well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Suzano has net debt worth 2.3x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 4.7x interest expense. . While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. Above all, Suzano has increased its EBIT by 45% in the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Suzano’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Suzano has recorded free cash flow of 73% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Suzano’s EBIT growth rate was a real plus in this analysis, as was its conversion of EBIT to free cash flow. On the other hand, our confidence has been shaken by his apparent struggle to manage his total liabilities. When we consider all the factors mentioned above, we feel a bit cautious about Suzano’s use of debt. While we understand that debt can improve return on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. 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 Suzano shows 3 warning signs in our investment analysis and 1 of them makes us a little uncomfortable…
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.
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