Locaweb Serviços de Internet (BVMF:LWSA3) Seems To Use Debt Quite Sensibly

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.' 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 the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Locaweb Serviços de Internet

How Much Debt Does Locaweb Serviços de Internet Carry?

You can click the graphic below for the historical numbers, but it shows that Locaweb Serviços de Internet had R$64.1m of debt in March 2021, down from R$126.4m, one year before. However, its balance sheet shows it holds R$2.41b in cash, so it actually has R$2.34b net cash.

A Look At Locaweb Serviços de Internet's Liabilities

We can see from the most recent balance sheet that Locaweb Serviços de Internet had liabilities of R$513.8m falling due within a year, and liabilities of R$441.5m due beyond that. Offsetting this, it had R$2.41b in cash and R$412.6m in receivables that were due within 12 months. So it actually has R$1.86b more liquid assets than total liabilities.

This surplus suggests that Locaweb Serviços de Internet has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Locaweb Serviços de Internet boasts net cash, so it's fair to say it does not have a heavy debt load!

One way Locaweb Serviços de Internet could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. 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'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. Locaweb Serviços de Internet may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Locaweb Serviços de Internet recorded free cash flow worth 51% 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Locaweb Serviços de Internet has net cash of R$2.34b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 11% in the last twelve months. 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. For example, we've discovered 2 warning signs for Locaweb Serviços de Internet that you should be aware of before investing here.

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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