Vulcabras Azaleia (BVMF: VULC3) takes certain risks with its use of debt
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu doesn’t care when he says, âThe biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital â. When we think about the risk level of a business, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that Vulcabras Azaleia SA (BVMF: VULC3) has a debt on its balance sheet. But should shareholders be worried about its use of debt?
When is debt dangerous?
Debt 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 stock price just to get its debt under control. Of course, many companies use debt to finance growth without any 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 was in 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.
How healthy is Vulcabras Azaleia’s track record?
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 receivables due within 12 months. Thus, he can boast of R $ 100.9 million in liquid assets more than total Liabilities.
This surplus suggests that Vulcabras Azaleia has a prudent balance sheet, and could probably eliminate its debt without too much difficulty.
In order to size a company’s debt against its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and profit before interest and taxes (EBIT) divided by its interest expenses. its interest coverage). In this way, we consider both the absolute quantum of the 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 12.0 times more. 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 the balance sheet tells us the most about debt. 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 out this free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a company cannot pay its debt with profits on paper; he needs cash. We must therefore clearly examine whether this EBIT leads to 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 Vulcabras Azaleia’s conversion of EBIT to free cash flow makes us cautious about this, its record of (non) growth in its EBIT is no better. But on the brighter side of life, its coverage of interest leaves us more sporty. In view of all the angles mentioned above, it seems to us that Vulcabras Azaleia is a somewhat risky investment because of its debt. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. There is no doubt that the balance sheet tells us the most about debt. 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 rock-solid balance sheet, then check out our list of cash-flow net-growth stocks right now.
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