These 4 Measures Indicate That Telefônica Brasil (BVMF:VIVT3) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Telefônica Brasil S.A. (BVMF:VIVT3) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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?

As you can see below, Telefônica Brasil had R$1.61b of debt at March 2021, down from R$4.32b a year prior. However, its balance sheet shows it holds R$6.90b in cash, so it actually has R$5.29b net cash.

How Healthy Is Telefônica Brasil's Balance Sheet?

We can see from the most recent balance sheet that Telefônica Brasil had liabilities of R$20.5b falling due within a year, and liabilities of R$20.7b due beyond that. On the other hand, it had cash of R$6.90b and R$11.3b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$23.1b.

Telefônica Brasil has a very large market capitalization of R$69.4b, so it could very likely raise cash to ameliorate 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. 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.

On the other hand, Telefônica Brasil's EBIT dived 17%, over the last year. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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 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$5.29b. And it impressed us with free cash flow of R$11b, being 123% of its EBIT. So we are not troubled with Telefônica Brasil's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. 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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