Here's Why PagSeguro Digital (NYSE:PAGS) Can Manage Its Debt Responsibly
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 PagSeguro Digital Ltd. (NYSE:PAGS) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for PagSeguro Digital
What Is PagSeguro Digital's Net Debt?
As you can see below, at the end of March 2022, PagSeguro Digital had R$1.30b of debt, up from none a year ago. Click the image for more detail. But it also has R$1.48b in cash to offset that, meaning it has R$180.0m net cash.
A Look At PagSeguro Digital's Liabilities
Zooming in on the latest balance sheet data, we can see that PagSeguro Digital had liabilities of R$20.9b due within 12 months and liabilities of R$2.09b due beyond that. Offsetting this, it had R$1.48b in cash and R$26.2b in receivables that were due within 12 months. So it actually has R$4.67b more liquid assets than total liabilities.
This excess liquidity suggests that PagSeguro Digital is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that PagSeguro Digital has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, PagSeguro Digital grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its 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 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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.
While we empathize with investors who find debt concerning, you should keep in mind that PagSeguro Digital has net cash of R$180.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 75% over the last year. So we are not troubled with PagSeguro Digital's debt use. 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. For instance, we've identified 3 warning signs for PagSeguro Digital (1 can't be ignored) you should be aware of.
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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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.
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