We Think Locaweb Serviços de Internet (BVMF:LWSA3) Can Stay On Top Of Its Debt

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. 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.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Locaweb Serviços de Internet

What Is Locaweb Serviços de Internet's Net Debt?

The image below, which you can click on for greater detail, shows that Locaweb Serviços de Internet had debt of R$33.1m at the end of September 2021, a reduction from R$98.4m over a year. However, its balance sheet shows it holds R$1.80b in cash, so it actually has R$1.77b net cash.

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$597.4m due within 12 months and liabilities of R$654.1m due beyond that. Offsetting these obligations, it had cash of R$1.80b as well as receivables valued at R$443.2m due within 12 months. So it actually has R$992.0m more liquid assets than total liabilities.

This excess liquidity suggests that Locaweb Serviços de Internet is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Locaweb Serviços de Internet has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Locaweb Serviços de Internet's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, Locaweb Serviços de Internet produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. 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$1.77b, as well as more liquid assets than liabilities. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in R$45m. So we are not troubled with Locaweb Serviços de Internet's debt use. 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. To that end, you should be aware of the 3 warning signs we've spotted with Locaweb Serviços de Internet .

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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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.