Does Vitru Brasil Empreendimentos Participações e Comércio (BVMF:VTRU3) Have A Healthy Balance Sheet?

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.' 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 Vitru Brasil Empreendimentos, Participações e Comércio S.A (BVMF:VTRU3) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Vitru Brasil Empreendimentos Participações e Comércio

How Much Debt Does Vitru Brasil Empreendimentos Participações e Comércio Carry?

As you can see below, at the end of September 2024, Vitru Brasil Empreendimentos Participações e Comércio had R$2.39b of debt, up from R$1.85b a year ago. Click the image for more detail. On the flip side, it has R$525.3m in cash leading to net debt of about R$1.86b.

How Strong Is Vitru Brasil Empreendimentos Participações e Comércio's Balance Sheet?

According to the last reported balance sheet, Vitru Brasil Empreendimentos Participações e Comércio had liabilities of R$626.4m due within 12 months, and liabilities of R$3.01b due beyond 12 months. Offsetting these obligations, it had cash of R$525.3m as well as receivables valued at R$305.3m due within 12 months. So its liabilities total R$2.81b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$748.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Vitru Brasil Empreendimentos Participações e Comércio would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While we wouldn't worry about Vitru Brasil Empreendimentos Participações e Comércio's net debt to EBITDA ratio of 3.2, we think its super-low interest cover of 1.4 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Looking on the bright side, Vitru Brasil Empreendimentos Participações e Comércio boosted its EBIT by a silky 35% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Vitru Brasil Empreendimentos Participações e Comércio's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. In the last three years, Vitru Brasil Empreendimentos Participações e Comércio's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Vitru Brasil Empreendimentos Participações e Comércio's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Vitru Brasil Empreendimentos Participações e Comércio's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Vitru Brasil Empreendimentos Participações e Comércio (at least 2 which are concerning) , and understanding them should be part of your investment process.

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.