Does Via Varejo (BVMF:VVAR3) Have A Healthy Balance Sheet?
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.’ 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. We note that Via Varejo S.A. (BVMF:VVAR3) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Via Varejo
What Is Via Varejo’s Net Debt?
As you can see below, at the end of March 2021, Via Varejo had R$10.5b of debt, up from R$7.19b a year ago. Click the image for more detail. However, it also had R$1.39b in cash, and so its net debt is R$9.14b.
A Look At Via Varejo’s Liabilities
The latest balance sheet data shows that Via Varejo had liabilities of R$19.3b due within a year, and liabilities of R$7.98b falling due after that. Offsetting these obligations, it had cash of R$1.39b as well as receivables valued at R$9.59b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$16.3b.
This is a mountain of leverage relative to its market capitalization of R$20.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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 we wouldn’t worry about Via Varejo’s net debt to EBITDA ratio of 4.1, we think its super-low interest cover of 2.4 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, it should be some comfort for shareholders to recall that Via Varejo actually grew its EBIT by a hefty 737%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. 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 Via Varejo’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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Via Varejo burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
We’d go so far as to say Via Varejo’s conversion of EBIT to free cash flow was disappointing. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Via Varejo stock a bit risky. That’s not necessarily a bad thing, but we’d generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. To that end, you should learn about the 3 warning signs we’ve spotted with Via Varejo (including 2 which are concerning) .
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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