Is Nemak S. A. B. de C. V (BMV:NEMAKA) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Nemak, S. A. B. de C. V. (BMV:NEMAKA) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Nemak S. A. B. de C. V

How Much Debt Does Nemak S. A. B. de C. V Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Nemak S. A. B. de C. V had debt of US$1.82b, up from US$1.58b in one year. However, because it has a cash reserve of US$261.8m, its net debt is less, at about US$1.55b.

How Strong Is Nemak S. A. B. de C. V's Balance Sheet?

The latest balance sheet data shows that Nemak S. A. B. de C. V had liabilities of US$1.98b due within a year, and liabilities of US$1.74b falling due after that. On the other hand, it had cash of US$261.8m and US$648.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.81b.

This deficit casts a shadow over the US$499.2m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Nemak S. A. B. de C. V would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Nemak S. A. B. de C. V's debt to EBITDA ratio (3.2) suggests that it uses some debt, its interest cover is very weak, at 2.3, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Another concern for investors might be that Nemak S. A. B. de C. V's EBIT fell 15% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Nemak S. A. B. de C. V'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Nemak S. A. B. de C. V actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Nemak S. A. B. de C. V's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. We think the chances that Nemak S. A. B. de C. V has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Nemak S. A. B. de C. V (of which 1 is a bit concerning!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.