Is Cementos Bio Bio (SNSE:CEMENTOS) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Cementos Bio Bio S.A. (SNSE:CEMENTOS) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Cementos Bio Bio

What Is Cementos Bio Bio's Net Debt?

As you can see below, at the end of September 2020, Cementos Bio Bio had CL$109.4b of debt, up from CL$101.7b a year ago. Click the image for more detail. On the flip side, it has CL$47.0b in cash leading to net debt of about CL$62.4b.

How Strong Is Cementos Bio Bio's Balance Sheet?

According to the last reported balance sheet, Cementos Bio Bio had liabilities of CL$59.8b due within 12 months, and liabilities of CL$140.1b due beyond 12 months. Offsetting these obligations, it had cash of CL$47.0b as well as receivables valued at CL$31.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$121.5b.

This deficit is considerable relative to its market capitalization of CL$200.0b, so it does suggest shareholders should keep an eye on Cementos Bio Bio's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cementos Bio Bio's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 4.4 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. If Cementos Bio Bio can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cementos Bio Bio will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Cementos Bio Bio actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

When it comes to the balance sheet, the standout positive for Cementos Bio Bio was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Cementos Bio Bio is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Take risks, for example - Cementos Bio Bio has 2 warning signs (and 1 which is concerning) we think you should know about.

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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