Is d1000 Varejo Farma Participações (BVMF:DMVF3) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies d1000 Varejo Farma Participações S.A. (BVMF:DMVF3) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for d1000 Varejo Farma Participações

What Is d1000 Varejo Farma Participações's Debt?

As you can see below, d1000 Varejo Farma Participações had R$21.6m of debt at September 2024, down from R$26.8m a year prior. However, its balance sheet shows it holds R$39.2m in cash, so it actually has R$17.6m net cash.

How Strong Is d1000 Varejo Farma Participações' Balance Sheet?

We can see from the most recent balance sheet that d1000 Varejo Farma Participações had liabilities of R$479.5m falling due within a year, and liabilities of R$348.1m due beyond that. On the other hand, it had cash of R$39.2m and R$236.1m worth of receivables due within a year. So its liabilities total R$552.3m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R$341.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, d1000 Varejo Farma Participações would probably need a major re-capitalization if its creditors were to demand repayment. Given that d1000 Varejo Farma Participações has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

It is well worth noting that d1000 Varejo Farma Participações's EBIT shot up like bamboo after rain, gaining 67% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since d1000 Varejo Farma Participações will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. d1000 Varejo Farma Participações may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, d1000 Varejo Farma Participações actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although d1000 Varejo Farma Participações's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$17.6m. The cherry on top was that in converted 161% of that EBIT to free cash flow, bringing in R$81m. So we don't have any problem with d1000 Varejo Farma Participações's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with d1000 Varejo Farma Participações .

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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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.