These 4 Measures Indicate That Vamos Locação de Caminhões Máquinas e Equipamentos (BVMF:VAMO3) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Vamos Locação de Caminhões, Máquinas e Equipamentos S.A. (BVMF:VAMO3) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See 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 December 2023 Vamos Locação de Caminhões Máquinas e Equipamentos had R$11.7b of debt, an increase on R$7.87b, over one year. On the flip side, it has R$2.29b in cash leading to net debt of about R$9.44b.

How Strong Is Vamos Locação de Caminhões Máquinas e Equipamentos' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vamos Locação de Caminhões Máquinas e Equipamentos had liabilities of R$3.41b due within 12 months and liabilities of R$12.7b due beyond that. On the other hand, it had cash of R$2.29b and R$1.49b worth of receivables due within a year. So its liabilities total R$12.3b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's R$8.31b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

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 1.6, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. On a lighter note, we note that Vamos Locação de Caminhões Máquinas e Equipamentos grew its EBIT by 29% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. 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 Vamos Locação de Caminhões Máquinas e Equipamentos'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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Vamos Locação de Caminhões Máquinas e Equipamentos saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Vamos Locação de Caminhões Máquinas e Equipamentos's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Vamos Locação de Caminhões Máquinas e Equipamentos to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Vamos Locação de Caminhões Máquinas e Equipamentos you should be aware of, and 3 of them make us uncomfortable.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.