TOTVS (BVMF:TOTS3) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that TOTVS S.A. (BVMF:TOTS3) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 TOTVS

What Is TOTVS's Debt?

You can click the graphic below for the historical numbers, but it shows that TOTVS had R$1.55b of debt in December 2022, down from R$1.61b, one year before. But it also has R$2.74b in cash to offset that, meaning it has R$1.19b net cash.

How Strong Is TOTVS' Balance Sheet?

The latest balance sheet data shows that TOTVS had liabilities of R$3.34b due within a year, and liabilities of R$2.69b falling due after that. Offsetting these obligations, it had cash of R$2.74b as well as receivables valued at R$563.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$2.73b.

Given TOTVS has a market capitalization of R$16.2b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, TOTVS boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, TOTVS grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if TOTVS 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. TOTVS 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, TOTVS generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While TOTVS does have more liabilities than liquid assets, it also has net cash of R$1.19b. And it impressed us with free cash flow of R$734m, being 91% of its EBIT. So is TOTVS's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of TOTVS's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.