Stock Analysis

Is Telefônica Brasil (BVMF:VIVT3) Using Too Much Debt?

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

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When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Telefônica Brasil

What Is Telefônica Brasil's Debt?

As you can see below, at the end of March 2022, Telefônica Brasil had R$3.72b of debt, up from R$1.61b a year ago. Click the image for more detail. However, it does have R$6.46b in cash offsetting this, leading to net cash of R$2.74b.

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BOVESPA:VIVT3 Debt to Equity History July 21st 2022

A Look At Telefônica Brasil's Liabilities

According to the last reported balance sheet, Telefônica Brasil had liabilities of R$21.7b due within 12 months, and liabilities of R$24.6b due beyond 12 months. Offsetting this, it had R$6.46b in cash and R$12.0b in receivables that were due within 12 months. So its liabilities total R$27.9b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Telefônica Brasil has a huge market capitalization of R$78.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Telefônica Brasil also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Telefônica Brasil saw its EBIT decline by 2.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Telefônica Brasil 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. Over the last three years, Telefônica Brasil actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Telefônica Brasil does have more liabilities than liquid assets, it also has net cash of R$2.74b. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in R$8.8b. So we don't have any problem with Telefônica Brasil's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Telefônica Brasil has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Valuation is complex, but we're here to simplify it.

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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.