These 4 Measures Indicate That Qualicorp Consultoria e Corretora de Seguros (BVMF:QUAL3) Is Using Debt Extensively

Simply Wall St · 09/29 11:04

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Qualicorp Consultoria e Corretora de Seguros S.A. (BVMF:QUAL3) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Qualicorp Consultoria e Corretora de Seguros

What Is Qualicorp Consultoria e Corretora de Seguros's Net Debt?

As you can see below, Qualicorp Consultoria e Corretora de Seguros had R$1.89b of debt at June 2024, down from R$2.21b a year prior. However, it also had R$795.3m in cash, and so its net debt is R$1.10b.

debt-equity-history-analysis
BOVESPA:QUAL3 Debt to Equity History September 29th 2024

How Strong Is Qualicorp Consultoria e Corretora de Seguros' Balance Sheet?

We can see from the most recent balance sheet that Qualicorp Consultoria e Corretora de Seguros had liabilities of R$1.44b falling due within a year, and liabilities of R$1.57b due beyond that. Offsetting these obligations, it had cash of R$795.3m as well as receivables valued at R$379.6m due within 12 months. So its liabilities total R$1.83b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R$645.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Qualicorp Consultoria e Corretora de Seguros would likely require a major re-capitalisation if it had to pay its creditors today.

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).

Qualicorp Consultoria e Corretora de Seguros's debt of just -105 times EBITDA is clearly modest. But strangely, EBIT was only 0.47 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Importantly, Qualicorp Consultoria e Corretora de Seguros's EBIT fell a jaw-dropping 71% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Qualicorp Consultoria e Corretora de Seguros can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Qualicorp Consultoria e Corretora de Seguros produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

To be frank both Qualicorp Consultoria e Corretora de Seguros's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We should also note that Healthcare industry companies like Qualicorp Consultoria e Corretora de Seguros commonly do use debt without problems. Overall, it seems to us that Qualicorp Consultoria e Corretora de Seguros's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Qualicorp Consultoria e Corretora de Seguros (2 are concerning!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.