Here's Why PagSeguro Digital (NYSE:PAGS) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 PagSeguro Digital Ltd. (NYSE:PAGS) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for PagSeguro Digital

What Is PagSeguro Digital's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 PagSeguro Digital had debt of R$1.14b, up from none in one year. However, its balance sheet shows it holds R$1.40b in cash, so it actually has R$260.8m net cash.

How Healthy Is PagSeguro Digital's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PagSeguro Digital had liabilities of R$28.3b due within 12 months and liabilities of R$3.48b due beyond that. Offsetting these obligations, it had cash of R$1.40b as well as receivables valued at R$35.2b due within 12 months. So it can boast R$4.82b more liquid assets than total liabilities.

This excess liquidity is a great indication that PagSeguro Digital's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that PagSeguro Digital has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, PagSeguro Digital's EBIT launched higher than Elon Musk, gaining a whopping 134% on last year. 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 PagSeguro Digital'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PagSeguro Digital has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, PagSeguro Digital recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that PagSeguro Digital has net cash of R$260.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 134% year-on-year EBIT growth. So we are not troubled with PagSeguro Digital's debt use. 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 PagSeguro Digital's earnings per share history for free.

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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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.