Is Vulcabras (BVMF:VULC3) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Vulcabras S.A. (BVMF:VULC3) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Vulcabras

What Is Vulcabras's Debt?

As you can see below, Vulcabras had R$373.9m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have R$363.4m in cash offsetting this, leading to net debt of about R$10.6m.

How Healthy Is Vulcabras' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vulcabras had liabilities of R$447.0m due within 12 months and liabilities of R$367.7m due beyond that. Offsetting this, it had R$363.4m in cash and R$907.9m in receivables that were due within 12 months. So it can boast R$456.7m more liquid assets than total liabilities.

This surplus suggests that Vulcabras has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, Vulcabras has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.017 times EBITDA and EBIT covering interest a whopping 21.9 times, it's clear that Vulcabras is not a desperate borrower. So relative to past earnings, the debt load seems trivial. In addition to that, we're happy to report that Vulcabras has boosted its EBIT by 41%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Vulcabras can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Vulcabras recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Vulcabras's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Zooming out, Vulcabras seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Vulcabras , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.