Dimed Distribuidora de Medicamentos (BVMF:PNVL3) Seems To Use Debt Quite Sensibly

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. We can see that Dimed S.A. Distribuidora de Medicamentos (BVMF:PNVL3) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dimed Distribuidora de Medicamentos

How Much Debt Does Dimed Distribuidora de Medicamentos Carry?

The image below, which you can click on for greater detail, shows that Dimed Distribuidora de Medicamentos had debt of R$165.9m at the end of September 2021, a reduction from R$298.1m over a year. But on the other hand it also has R$205.5m in cash, leading to a R$39.6m net cash position.

How Strong Is Dimed Distribuidora de Medicamentos' Balance Sheet?

The latest balance sheet data shows that Dimed Distribuidora de Medicamentos had liabilities of R$686.7m due within a year, and liabilities of R$537.8m falling due after that. Offsetting these obligations, it had cash of R$205.5m as well as receivables valued at R$412.2m due within 12 months. So its liabilities total R$606.8m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Dimed Distribuidora de Medicamentos has a market capitalization of R$1.80b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Dimed Distribuidora de Medicamentos also has more cash than debt, so we're pretty confident it can manage its debt safely.

One way Dimed Distribuidora de Medicamentos could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dimed Distribuidora de Medicamentos's ability to maintain a healthy balance sheet going forward. 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. Dimed Distribuidora de Medicamentos 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. Looking at the most recent three years, Dimed Distribuidora de Medicamentos recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Dimed Distribuidora de Medicamentos does have more liabilities than liquid assets, it also has net cash of R$39.6m. On top of that, it increased its EBIT by 13% in the last twelve months. So we don't have any problem with Dimed Distribuidora de Medicamentos's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Dimed Distribuidora de Medicamentos's earnings per share history for free.

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.