These 4 Measures Indicate That Vulcabras Azaleia (BVMF:VULC3) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Vulcabras Azaleia S.A. (BVMF:VULC3) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Vulcabras Azaleia

How Much Debt Does Vulcabras Azaleia Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Vulcabras Azaleia had R$330.7m of debt, an increase on R$61.4m, over one year. However, it does have R$273.2m in cash offsetting this, leading to net debt of about R$57.5m.

How Strong Is Vulcabras Azaleia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vulcabras Azaleia had liabilities of R$310.6m due within 12 months and liabilities of R$268.0m due beyond that. On the other hand, it had cash of R$273.2m and R$482.9m worth of receivables due within a year. So it actually has R$177.6m more liquid assets than total liabilities.

This surplus suggests that Vulcabras Azaleia has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Vulcabras Azaleia's net debt is only 0.41 times its EBITDA. And its EBIT covers its interest expense a whopping 59.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Vulcabras Azaleia if management cannot prevent a repeat of the 50% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Vulcabras Azaleia'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Vulcabras Azaleia recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Based on what we've seen Vulcabras Azaleia is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the elements mentioned above, it seems to us that Vulcabras Azaleia is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Vulcabras Azaleia has 2 warning signs we think you should be aware of.

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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