We Think Afya (NASDAQ:AFYA) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Afya Limited (NASDAQ:AFYA) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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?

As you can see below, at the end of September 2024, Afya had R$2.15b of debt, up from R$1.96b a year ago. Click the image for more detail. 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. Offsetting these obligations, it had cash of R$836.9m as well as receivables valued at R$593.8m due within 12 months. 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$9.06b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 1.1 and interest cover of 3.9 times, it seems to us that Afya is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Also relevant is that Afya has grown its EBIT by a very respectable 26% in the last year, thus enhancing its ability to pay down debt. 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'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. During the last three years, Afya generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Afya's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its interest cover does undermine this impression a bit. When we consider the range of factors above, it looks like Afya is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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.