Does Locaweb Serviços de Internet (BVMF:LWSA3) Have A Healthy Balance Sheet?

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.' 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 Locaweb Serviços de Internet S.A. (BVMF:LWSA3) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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.

See our latest analysis for Locaweb Serviços de Internet

What Is Locaweb Serviços de Internet's Debt?

The image below, which you can click on for greater detail, shows that Locaweb Serviços de Internet had debt of R$84.6m at the end of December 2020, a reduction from R$116.5m over a year. But on the other hand it also has R$404.6m in cash, leading to a R$320.1m net cash position.

A Look At Locaweb Serviços de Internet's Liabilities

According to the last reported balance sheet, Locaweb Serviços de Internet had liabilities of R$450.6m due within 12 months, and liabilities of R$327.8m due beyond 12 months. Offsetting these obligations, it had cash of R$404.6m as well as receivables valued at R$367.1m due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Locaweb Serviços de Internet's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the R$16.1b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Locaweb Serviços de Internet also has more cash than debt, so we're pretty confident it can manage its debt safely.

Unfortunately, Locaweb Serviços de Internet saw its EBIT slide 6.2% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 Locaweb Serviços de Internet 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Locaweb Serviços de Internet 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. During the last three years, Locaweb Serviços de Internet produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Locaweb Serviços de Internet has R$320.1m in net cash. So we don't have any problem with Locaweb Serviços de Internet's use of debt. 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. We've identified 2 warning signs with Locaweb Serviços de Internet , and understanding them should be part of your investment process.

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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