Here's Why Urbas Grupo Financiero (BME:UBS) Has A Meaningful Debt Burden

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.' 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. As with many other companies Urbas Grupo Financiero, S.A. (BME:UBS) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Urbas Grupo Financiero

What Is Urbas Grupo Financiero's Debt?

As you can see below, at the end of September 2020, Urbas Grupo Financiero had €232.5m of debt, up from €193.2m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Urbas Grupo Financiero's Balance Sheet?

We can see from the most recent balance sheet that Urbas Grupo Financiero had liabilities of €245.0m falling due within a year, and liabilities of €32.4m due beyond that. Offsetting this, it had €4.18m in cash and €21.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €251.3m.

This deficit isn't so bad because Urbas Grupo Financiero is worth €613.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

As it happens Urbas Grupo Financiero has a fairly concerning net debt to EBITDA ratio of 600 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, Urbas Grupo Financiero's EBIT fell a jaw-dropping 96% 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 you can't view debt in total isolation; since Urbas Grupo Financiero 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Urbas Grupo Financiero saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Urbas Grupo Financiero's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Urbas Grupo Financiero to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Urbas Grupo Financiero (1 is a bit concerning) 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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