We Think Positivo Tecnologia (BVMF:POSI3) Is Taking Some Risk With Its Debt

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.' 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 Positivo Tecnologia S.A. (BVMF:POSI3) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Positivo Tecnologia

What Is Positivo Tecnologia's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Positivo Tecnologia had R$1.54b of debt, an increase on R$1.29b, over one year. On the flip side, it has R$601.5m in cash leading to net debt of about R$941.0m.

A Look At Positivo Tecnologia's Liabilities

We can see from the most recent balance sheet that Positivo Tecnologia had liabilities of R$1.59b falling due within a year, and liabilities of R$956.2m due beyond that. Offsetting this, it had R$601.5m in cash and R$1.15b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$795.6m.

This is a mountain of leverage relative to its market capitalization of R$1.06b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Positivo Tecnologia has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 2.3. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Importantly, Positivo Tecnologia grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Positivo Tecnologia's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Positivo Tecnologia burned a lot of cash. 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

Neither Positivo Tecnologia's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think Positivo Tecnologia's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Positivo Tecnologia has 3 warning signs (and 2 which are concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.