Is Afya (NASDAQ:AFYA) Using Too Much Debt?

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 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 Afya Limited (NASDAQ:AFYA) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Afya

What Is Afya's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Afya had R$236.9m of debt, an increase on R$82.2m, over one year. But on the other hand it also has R$1.08b in cash, leading to a R$839.8m net cash position.

How Healthy Is Afya's Balance Sheet?

According to the last reported balance sheet, Afya had liabilities of R$572.5m due within 12 months, and liabilities of R$711.5m due beyond 12 months. Offsetting these obligations, it had cash of R$1.08b as well as receivables valued at R$255.6m due within 12 months. So it actually has R$48.4m more liquid assets than total liabilities.

This state of affairs indicates that Afya's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the R$11.8b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Afya has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Afya has boosted its EBIT by 92%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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. Afya 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 most recent three years, Afya recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Afya has net cash of R$839.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 92% year-on-year EBIT growth. So we don't think Afya's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Afya, you may well want to click here to check an interactive graph of its earnings per share history.

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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