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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. 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?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is MercadoLibre's Debt?

The chart below, which you can click on for greater detail, shows that MercadoLibre had US$4.55b in debt in June 2024; about the same as the year before. However, its balance sheet shows it holds US$6.89b in cash, so it actually has US$2.34b net cash.

How Strong Is MercadoLibre's Balance Sheet?

According to the last reported balance sheet, MercadoLibre had liabilities of US$12.9b due within 12 months, and liabilities of US$3.46b due beyond 12 months. Offsetting these obligations, it had cash of US$6.89b as well as receivables valued at US$7.80b due within 12 months. So it has liabilities totalling US$1.69b more than its cash and near-term receivables, combined.

Having regard to MercadoLibre's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$101.4b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, MercadoLibre also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that MercadoLibre has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. 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 MercadoLibre'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. 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. Happily for any shareholders, MercadoLibre actually produced more free cash flow than EBIT over the last three years. 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$2.34b in net cash. The cherry on top was that in converted 232% of that EBIT to free cash flow, bringing in US$5.6b. So we don't think MercadoLibre's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of MercadoLibre's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.