We Think Hapvida Participações e Investimentos (BVMF:HAPV3) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hapvida Participações e Investimentos S.A. (BVMF:HAPV3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hapvida Participações e Investimentos

How Much Debt Does Hapvida Participações e Investimentos Carry?

The chart below, which you can click on for greater detail, shows that Hapvida Participações e Investimentos had R$2.06b in debt in September 2021; about the same as the year before. However, it does have R$2.53b in cash offsetting this, leading to net cash of R$472.4m.

How Strong Is Hapvida Participações e Investimentos' Balance Sheet?

The latest balance sheet data shows that Hapvida Participações e Investimentos had liabilities of R$3.27b due within a year, and liabilities of R$3.52b falling due after that. Offsetting this, it had R$2.53b in cash and R$626.1m in receivables that were due within 12 months. So its liabilities total R$3.62b more than the combination of its cash and short-term receivables.

Since publicly traded Hapvida Participações e Investimentos shares are worth a total of R$41.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Hapvida Participações e Investimentos boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Hapvida Participações e Investimentos's EBIT was down 52% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hapvida Participações e Investimentos'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hapvida Participações e Investimentos has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Hapvida Participações e Investimentos recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about Hapvida Participações e Investimentos's liabilities, but we can be reassured by the fact it has has net cash of R$472.4m. So while Hapvida Participações e Investimentos does not have a great balance sheet, it's certainly not too bad. 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. Case in point: We've spotted 4 warning signs for Hapvida Participações e Investimentos you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.