Does Arco Platform (NASDAQ:ARCE) Have A Healthy Balance Sheet?
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Arco Platform Limited (NASDAQ:ARCE) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Arco Platform
What Is Arco Platform's Debt?
The chart below, which you can click on for greater detail, shows that Arco Platform had R$309.6m in debt in March 2021; about the same as the year before. However, its balance sheet shows it holds R$1.02b in cash, so it actually has R$708.1m net cash.
How Healthy Is Arco Platform's Balance Sheet?
We can see from the most recent balance sheet that Arco Platform had liabilities of R$1.23b falling due within a year, and liabilities of R$1.23b due beyond that. On the other hand, it had cash of R$1.02b and R$548.5m worth of receivables due within a year. So it has liabilities totalling R$898.3m more than its cash and near-term receivables, combined.
Since publicly traded Arco Platform shares are worth a total of R$8.04b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Arco Platform also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is well worth noting that Arco Platform's EBIT shot up like bamboo after rain, gaining 83% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Arco Platform's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Arco Platform may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Arco Platform actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Summing up
Although Arco Platform's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$708.1m. And it impressed us with its EBIT growth of 83% over the last year. So we are not troubled with Arco Platform's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Arco Platform that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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