Nexa Resources (NYSE: NEXA) takes some risk with its use of debt

Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. 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. Like many other companies Nexa Resources SA (NYSE: NEXA) uses debt. But the more important question is: what risk does this debt create?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. 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, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for Nexa Resources

What is Nexa Resources’ net debt?

As you can see below, Nexa Resources had $1.67 billion in debt in June 2022, up from $1.91 billion the previous year. However, since he has a cash reserve of $632.6 million, his net debt is less, at around $1.04 billion.

NYSE: NEXA Debt to Equity History August 24, 2022

How strong is Nexa Resources’ balance sheet?

The latest balance sheet data shows that Nexa Resources had liabilities of $1.03 billion due within the year, and liabilities of $2.23 billion due thereafter. In return, he had $632.6 million in cash and $196.8 million in receivables due within 12 months. Thus, its liabilities total $2.44 billion more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the $796.0 million business itself, like a child struggling under the weight of a huge backpack full of books, his gym gear and a trumpet. . We would therefore be watching his balance sheet closely, no doubt. Ultimately, Nexa Resources would likely need a significant recapitalization if its creditors demanded repayment.

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.

Given its net debt to EBITDA of 1.3 and interest coverage of 4.7 times, it seems to us that Nexa Resources is probably using debt quite sensibly. We therefore recommend that you closely monitor the impact of financing costs on the business. If Nexa Resources can continue to grow EBIT at last year’s rate of 12% from last year, then it will find its leverage easier to manage. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Nexa Resources 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 company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past two years, Nexa Resources has reported free cash flow of 13% of its EBIT, which is really very low. This low level of cash conversion compromises its ability to manage and repay its debt.

Our point of view

Reflecting on Nexa Resources’ attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But at least it’s decent enough to increase its EBIT; it’s encouraging. Overall, we think it’s fair to say that Nexa Resources has enough debt that there are real risks around the balance sheet. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. 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 outside of the balance sheet. Example: we have identified 2 warning signs for Nexa Resources you should be aware.

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.

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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