Does Cogna Educação (BVMF:COGN3) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Cogna Educação S.A. (BVMF:COGN3) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that COGN3 is potentially undervalued!

What Is Cogna Educação's Debt?

As you can see below, Cogna Educação had R$6.61b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, it also had R$3.74b in cash, and so its net debt is R$2.88b.

A Look At Cogna Educação's Liabilities

The latest balance sheet data shows that Cogna Educação had liabilities of R$4.53b due within a year, and liabilities of R$9.73b falling due after that. Offsetting this, it had R$3.74b in cash and R$2.44b in receivables that were due within 12 months. So it has liabilities totalling R$8.08b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of R$5.49b, we think shareholders really should watch Cogna Educação's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cogna Educação shareholders face the double whammy of a high net debt to EBITDA ratio (6.4), and fairly weak interest coverage, since EBIT is just 0.47 times the interest expense. The debt burden here is substantial. One redeeming factor for Cogna Educação is that it turned last year's EBIT loss into a gain of R$252m, over the last twelve months. 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 Cogna Educação can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Considering the last year, Cogna Educação actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Cogna Educação's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Cogna Educação has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. While Cogna Educação didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.