Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that MercadoLibre, Inc. (NASDAQ:MELI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is MercadoLibre's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 MercadoLibre had US$5.27b of debt, an increase on US$4.40b, over one year. However, its balance sheet shows it holds US$6.67b in cash, so it actually has US$1.41b net cash.

A Look At MercadoLibre's Liabilities

We can see from the most recent balance sheet that MercadoLibre had liabilities of US$14.3b falling due within a year, and liabilities of US$4.31b due beyond that. Offsetting these obligations, it had cash of US$6.67b as well as receivables valued at US$9.05b due within 12 months. So its liabilities total US$2.90b more than the combination of its cash and short-term receivables.

Given MercadoLibre has a humongous market capitalization of US$97.8b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, MercadoLibre boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that MercadoLibre saw its EBIT decline by 4.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if MercadoLibre can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While MercadoLibre has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, MercadoLibre actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that MercadoLibre has US$1.41b in net cash. And it impressed us with free cash flow of US$6.2b, being 239% of its EBIT. So is MercadoLibre's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in MercadoLibre, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 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.