Is Telefônica Brasil (BVMF:VIVT3) A Risky Investment?

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.' 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. As with many other companies Telefônica Brasil S.A. (BVMF:VIVT3) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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.

View our latest analysis for Telefônica Brasil

What Is Telefônica Brasil's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Telefônica Brasil had R$2.50b of debt in December 2020, down from R$4.69b, one year before. But it also has R$5.76b in cash to offset that, meaning it has R$3.27b net cash.

A Look At Telefônica Brasil's Liabilities

The latest balance sheet data shows that Telefônica Brasil had liabilities of R$17.9b due within a year, and liabilities of R$21.3b falling due after that. Offsetting these obligations, it had cash of R$5.76b as well as receivables valued at R$11.2b due within 12 months. So its liabilities total R$22.2b more than the combination of its cash and short-term receivables.

Telefônica Brasil has a very large market capitalization of R$78.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 14% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Telefônica Brasil 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, 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. Over the last three years, Telefônica Brasil actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Telefônica Brasil's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$3.27b. And it impressed us with free cash flow of R$11b, being 111% of its EBIT. 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. To that end, you should be aware of the 1 warning sign we've spotted with Telefônica Brasil .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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