Is Vamos Locação de Caminhões Máquinas e Equipamentos (BVMF:VAMO3) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Vamos Locação de Caminhões, Máquinas e Equipamentos S.A. (BVMF:VAMO3) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Vamos Locação de Caminhões Máquinas e Equipamentos

How Much Debt Does Vamos Locação de Caminhões Máquinas e Equipamentos Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Vamos Locação de Caminhões Máquinas e Equipamentos had R$12.6b of debt, an increase on R$9.72b, over one year. However, because it has a cash reserve of R$2.45b, its net debt is less, at about R$10.2b.

A Look At Vamos Locação de Caminhões Máquinas e Equipamentos' Liabilities

Zooming in on the latest balance sheet data, we can see that Vamos Locação de Caminhões Máquinas e Equipamentos had liabilities of R$4.64b due within 12 months and liabilities of R$12.8b due beyond that. Offsetting these obligations, it had cash of R$2.45b as well as receivables valued at R$1.59b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$13.4b.

When you consider that this deficiency exceeds the company's R$9.07b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Vamos Locação de Caminhões Máquinas e Equipamentos's debt to EBITDA ratio (3.6) suggests that it uses some debt, its interest cover is very weak, at 1.5, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, one redeeming factor is that Vamos Locação de Caminhões Máquinas e Equipamentos grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Vamos Locação de Caminhões Máquinas e Equipamentos 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Vamos Locação de Caminhões Máquinas e Equipamentos saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Vamos Locação de Caminhões Máquinas e Equipamentos's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, it seems to us that Vamos Locação de Caminhões Máquinas e Equipamentos's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Be aware that Vamos Locação de Caminhões Máquinas e Equipamentos is showing 4 warning signs in our investment analysis , and 3 of those make us uncomfortable...

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.

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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.