We Think Construcciones y Auxiliar de Ferrocarriles (BME:CAF) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Construcciones y Auxiliar de Ferrocarriles, S.A. (BME:CAF) does carry debt. But is this debt a concern to shareholders?

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What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Construcciones y Auxiliar de Ferrocarriles's Debt?

As you can see below, Construcciones y Auxiliar de Ferrocarriles had €822.3m of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have €598.7m in cash offsetting this, leading to net debt of about €223.5m.

How Strong Is Construcciones y Auxiliar de Ferrocarriles' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Construcciones y Auxiliar de Ferrocarriles had liabilities of €3.32b due within 12 months and liabilities of €1.00b due beyond that. On the other hand, it had cash of €598.7m and €2.49b worth of receivables due within a year. So it has liabilities totalling €1.24b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €1.36b, so it does suggest shareholders should keep an eye on Construcciones y Auxiliar de Ferrocarriles' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

See our latest analysis for Construcciones y Auxiliar de Ferrocarriles

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Construcciones y Auxiliar de Ferrocarriles has a low net debt to EBITDA ratio of only 0.83. And its EBIT covers its interest expense a whopping 10.1 times over. So we're pretty relaxed about its super-conservative use of debt. Also good is that Construcciones y Auxiliar de Ferrocarriles grew its EBIT at 18% over the last year, further increasing its ability to manage debt. 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 Construcciones y Auxiliar de Ferrocarriles 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Construcciones y Auxiliar de Ferrocarriles recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Construcciones y Auxiliar de Ferrocarriles's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Construcciones y Auxiliar de Ferrocarriles's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 - Construcciones y Auxiliar de Ferrocarriles has 1 warning sign we think you should be aware of.

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.