Here's Why Tortilla Mexican Grill (LON:MEX) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Tortilla Mexican Grill plc (LON:MEX) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tortilla Mexican Grill

What Is Tortilla Mexican Grill's Debt?

The chart below, which you can click on for greater detail, shows that Tortilla Mexican Grill had UK£2.95m in debt in December 2023; about the same as the year before. However, because it has a cash reserve of UK£1.64m, its net debt is less, at about UK£1.30m.

A Look At Tortilla Mexican Grill's Liabilities

According to the last reported balance sheet, Tortilla Mexican Grill had liabilities of UK£15.4m due within 12 months, and liabilities of UK£33.1m due beyond 12 months. On the other hand, it had cash of UK£1.64m and UK£2.12m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£44.8m.

This deficit casts a shadow over the UK£22.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Tortilla Mexican Grill would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Given net debt is only 0.26 times EBITDA, it is initially surprising to see that Tortilla Mexican Grill's EBIT has low interest coverage of 0.63 times. So one way or the other, it's clear the debt levels are not trivial. Tortilla Mexican Grill grew its EBIT by 3.0% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to 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 Tortilla Mexican Grill'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Tortilla Mexican Grill actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

While Tortilla Mexican Grill's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and net debt to EBITDA were encouraging signs. Taking the abovementioned factors together we do think Tortilla Mexican Grill's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Tortilla Mexican Grill that you should be aware of before investing here.

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.

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