These 4 Measures Indicate That Qualicorp Consultoria e Corretora de Seguros (BVMF:QUAL3) Is Using Debt Reasonably Well

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.' 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 can see that Qualicorp Consultoria e Corretora de Seguros S.A. (BVMF:QUAL3) does use debt in its business. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Qualicorp Consultoria e Corretora de Seguros

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

The image below, which you can click on for greater detail, shows that at June 2022 Qualicorp Consultoria e Corretora de Seguros had debt of R$2.60b, up from R$1.65b in one year. However, it does have R$1.09b in cash offsetting this, leading to net debt of about R$1.51b.

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$1.08b due within a year, and liabilities of R$2.45b falling due after that. On the other hand, it had cash of R$1.09b and R$382.9m worth of receivables due within a year. So its liabilities total R$2.05b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of R$2.52b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Qualicorp Consultoria e Corretora de Seguros has a debt to EBITDA ratio of 2.6, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 17.2 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Unfortunately, Qualicorp Consultoria e Corretora de Seguros saw its EBIT slide 3.7% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Qualicorp Consultoria e Corretora de Seguros 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Qualicorp Consultoria e Corretora de Seguros recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Qualicorp Consultoria e Corretora de Seguros's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. It's also worth noting that Qualicorp Consultoria e Corretora de Seguros is in the Healthcare industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Qualicorp Consultoria e Corretora de Seguros's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Qualicorp Consultoria e Corretora de Seguros , 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.