Positivo Tecnologia (BVMF:POSI3) Has A Somewhat Strained Balance Sheet

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.' 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. Importantly, Positivo Tecnologia S.A. (BVMF:POSI3) does carry debt. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Positivo Tecnologia

What Is Positivo Tecnologia's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Positivo Tecnologia had R$1.29b of debt in September 2023, down from R$1.45b, one year before. However, it does have R$388.6m in cash offsetting this, leading to net debt of about R$898.4m.

A Look At Positivo Tecnologia's Liabilities

According to the last reported balance sheet, Positivo Tecnologia had liabilities of R$1.84b due within 12 months, and liabilities of R$885.0m due beyond 12 months. On the other hand, it had cash of R$388.6m and R$1.20b worth of receivables due within a year. So it has liabilities totalling R$1.13b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's R$1.11b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Positivo Tecnologia's debt is only 1.9, its interest cover is really very low at 2.2. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Notably Positivo Tecnologia's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Positivo Tecnologia 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Positivo Tecnologia saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Positivo Tecnologia's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. We're quite clear that we consider Positivo Tecnologia to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Positivo Tecnologia you should be aware of, and 1 of them is potentially serious.

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.