Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to 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. We can see that Qualicorp Consultoria and Corretora de Seguros SA (BVMF:QUAL3) uses debt in its business. But should shareholders worry about its use of debt?
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Qualicorp Consultoria e Corretora de Seguros
What is the net debt of Qualicorp Consultoria e Corretora de Seguros?
The image below, which you can click on for more details, shows that in June 2022, Qualicorp Consultoria e Corretora de Seguros had a debt of R$2.60 billion, compared to R$1.65 billion in one year. However, he has 1.09 billion reais in cash to offset this, resulting in a net debt of around 1.51 billion reais.
What is the balance sheet of Qualicorp Consultoria e Corretora de Seguros?
The latest balance sheet data shows that Qualicorp Consultoria e Corretora de Seguros had liabilities of R$1.08 billion due within one year, and liabilities of R$2.45 billion falling due thereafter. . On the other hand, it had cash of 1.09 billion reais and 382.9 million reais of receivables due within a year. Thus, its liabilities total 2.05 billion reais more than the combination of its cash and short-term receivables.
This is a mountain of leverage compared to its market capitalization of 2.52 billion reais. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
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.
Qualicorp Consultoria e Corretora de Seguros has a debt to EBITDA ratio of 2.6, which signals significant debt, but is still quite reasonable for most types of businesses. But its EBIT was around 17.2 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. Unfortunately, Qualicorp Consultoria e Corretora de Seguros has seen its EBIT fall by 3.7% over the last twelve months. If this earnings trend continues, its leverage will become heavy like the heart of a polar bear looking at its only cub. 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 Qualicorp Consultoria e Corretora de Seguros can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Qualicorp Consultoria e Corretora de Seguros has recorded free cash flow representing 57% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
According to our analysis, the interest coverage of Qualicorp Consultoria e Corretora de Seguros should signal that it will not have too many problems with its debt. However, our other observations were not so encouraging. For example, it looks like he has to struggle a bit to manage his total liabilities. It should also be noted that Qualicorp Consultoria e Corretora de Seguros belongs to the health sector, which is often considered quite defensive. Looking at all this data, we feel a bit cautious about Qualicorp Consultoria e Corretora de Seguros’ debt level. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 3 warning signs with Qualicorp Consultoria e Corretora de Seguros, and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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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