The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Cogna Educação S.A. (BVMF:COGN3) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Cogna Educação's Debt?
You can click the graphic below for the historical numbers, but it shows that Cogna Educação had R$6.50b of debt in March 2021, down from R$7.98b, one year before. However, because it has a cash reserve of R$3.48b, its net debt is less, at about R$3.02b.
How Healthy Is Cogna Educação's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Cogna Educação had liabilities of R$9.63b due within 12 months and liabilities of R$5.97b due beyond that. Offsetting these obligations, it had cash of R$3.48b as well as receivables valued at R$2.10b due within 12 months. So it has liabilities totalling R$10.0b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of R$7.59b, we think shareholders really should watch Cogna Educação's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Cogna Educação made a loss at the EBIT level, and saw its revenue drop to R$4.9b, which is a fall of 17%. We would much prefer see growth.
While Cogna Educação's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable R$808m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of R$3.6b didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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, we've discovered 1 warning sign for Cogna Educação that you should be aware of before investing here.
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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