Locaweb Serviços de Internet (BVMF:LWSA3) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Locaweb Serviços de Internet S.A. (BVMF:LWSA3) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Locaweb Serviços de Internet

What Is Locaweb Serviços de Internet's Net Debt?

As you can see below, Locaweb Serviços de Internet had R$10.4m of debt at March 2022, down from R$64.1m a year prior. But on the other hand it also has R$1.54b in cash, leading to a R$1.53b net cash position.

How Healthy Is Locaweb Serviços de Internet's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Locaweb Serviços de Internet had liabilities of R$798.3m due within 12 months and liabilities of R$884.0m due beyond that. Offsetting these obligations, it had cash of R$1.54b as well as receivables valued at R$616.7m due within 12 months. So it can boast R$479.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Locaweb Serviços de Internet could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Locaweb Serviços de Internet boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Locaweb Serviços de Internet grew its EBIT at 17% over the last year, further increasing its ability to manage 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 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 74% 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$1.53b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of R$48m, being 74% of its EBIT. So is Locaweb Serviços de Internet's debt a risk? It doesn't seem so to us. 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 instance, we've identified 1 warning sign for Locaweb Serviços de Internet that you should be aware of.

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.