Afya (NASDAQ:AFYA) Seems To Use Debt Quite Sensibly

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 note that Afya Limited (NASDAQ:AFYA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Afya

What Is Afya's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Afya had debt of R$2.15b, up from R$1.96b in one year. However, because it has a cash reserve of R$836.9m, its net debt is less, at about R$1.31b.

How Strong Is Afya's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Afya had liabilities of R$925.2m due within 12 months and liabilities of R$3.64b due beyond that. On the other hand, it had cash of R$836.9m and R$593.8m worth of receivables due within a year. So it has liabilities totalling R$3.13b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Afya has a market capitalization of R$8.39b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Given net debt is only 1.1 times EBITDA, it is initially surprising to see that Afya's EBIT has low interest coverage of 2.4 times. So while we're not necessarily alarmed we think that its debt is far from trivial. We note that Afya grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Afya'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Afya recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Afya's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Taking all this data into account, it seems to us that Afya takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Afya's earnings per share history for free.

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.

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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.