Does Telefônica Brasil (BVMF:VIVT3) Have A Healthy 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.' 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 Telefônica Brasil S.A. (BVMF:VIVT3) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Telefônica Brasil

How Much Debt Does Telefônica Brasil Carry?

You can click the graphic below for the historical numbers, but it shows that Telefônica Brasil had R$1.58b of debt in June 2021, down from R$4.20b, one year before. However, its balance sheet shows it holds R$8.43b in cash, so it actually has R$6.86b net cash.

A Look At Telefônica Brasil's Liabilities

The latest balance sheet data shows that Telefônica Brasil had liabilities of R$23.4b due within a year, and liabilities of R$21.6b falling due after that. Offsetting this, it had R$8.43b in cash and R$12.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$23.8b.

This deficit isn't so bad because Telefônica Brasil is worth a massive R$75.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Telefônica Brasil boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Telefônica Brasil has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Telefônica Brasil'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Telefônica Brasil has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Telefônica Brasil actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While Telefônica Brasil does have more liabilities than liquid assets, it also has net cash of R$6.86b. The cherry on top was that in converted 135% of that EBIT to free cash flow, bringing in R$10b. So we don't have any problem with Telefônica Brasil's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Telefônica Brasil (1 is potentially serious) you should be aware of.

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.

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.

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