Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that Vulcabras Azalée SA (BVMF: VULC3) has a debt on its balance sheet. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Vulcabras Azaleia
What is Vulcabras Azaleia’s net debt?
As you can see below, at the end of March 2021, Vulcabras Azaleia had a debt of R $ 311.6 million, up from R $ 81.0 million a year ago. Click on the image for more details. However, because it has a cash reserve of R $ 146.8 million, its net debt is lower, at around R $ 164.8 million.
Is Vulcabras Azaleia’s track record healthy?
Zooming in on the latest balance sheet data, we can see that Vulcabras Azaleia had liabilities of R $ 334.0 million due within 12 months and liabilities of R $ 227.6 million due beyond. In return, he had R $ 146.8 million in cash and R $ 515.7 million in debts due within 12 months. He can therefore boast of 100.9 million reais of liquid assets more than total Liabilities.
This surplus suggests that Vulcabras Azaleia has a conservative balance sheet, and could probably eliminate its debt without too much difficulty.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Vulcabras Azaleia’s net debt is only 1.0 times its EBITDA. And its EBIT covers its interest costs a whopping 12.0 times. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. In fact, Vulcabras Azaleia’s saving grace is its low level of debt, as its EBIT has fallen 24% in the past twelve months. When it comes to paying down debt, lower income is no more helpful to your health than sugary sodas. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Vulcabras Azaleia can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. In the past three years, Vulcabras Azaleia has burned a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
While the conversion of Vulcabras Azaleia’s EBIT to free cash flow makes us cautious about this, its track record of (not) growing its EBIT is no better. But on the bright side of life, his coverage of interests leaves us feeling more playful. Looking at all the angles mentioned above, it seems to us that Vulcabras Azaleia is a somewhat risky investment due to its debt. This is not necessarily a bad thing, as leverage can increase return on equity, but it is something to be aware of. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example – Vulcabras Azaleia has 2 warning signs we think you should be aware of this.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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