Here's Why Qualicorp Consultoria e Corretora de Seguros (BVMF:QUAL3) Is Weighed Down By Its Debt Load

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Qualicorp Consultoria e Corretora de Seguros S.A. (BVMF:QUAL3) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

Check out our latest analysis for Qualicorp Consultoria e Corretora de Seguros

What Is Qualicorp Consultoria e Corretora de Seguros's Net Debt?

As you can see below, Qualicorp Consultoria e Corretora de Seguros had R$2.21b of debt at June 2023, down from R$2.60b a year prior. On the flip side, it has R$861.8m in cash leading to net debt of about R$1.35b.

How Healthy Is Qualicorp Consultoria e Corretora de Seguros' Balance Sheet?

The latest balance sheet data shows that Qualicorp Consultoria e Corretora de Seguros had liabilities of R$1.26b due within a year, and liabilities of R$1.94b falling due after that. Offsetting these obligations, it had cash of R$861.8m as well as receivables valued at R$309.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$2.02b.

The deficiency here weighs heavily on the R$925.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Qualicorp Consultoria e Corretora de Seguros would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Qualicorp Consultoria e Corretora de Seguros shareholders face the double whammy of a high net debt to EBITDA ratio (6.3), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. The debt burden here is substantial. Even worse, Qualicorp Consultoria e Corretora de Seguros saw its EBIT tank 58% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Qualicorp Consultoria e Corretora de Seguros 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Qualicorp Consultoria e Corretora de Seguros recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Qualicorp Consultoria e Corretora de Seguros's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. We should also note that Healthcare industry companies like Qualicorp Consultoria e Corretora de Seguros commonly do use debt without problems. After considering the datapoints discussed, we think Qualicorp Consultoria e Corretora de Seguros has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Qualicorp Consultoria e Corretora de Seguros (1 is significant!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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