These 4 Measures Indicate That Nemak S. A. B. de C. V (BMV:NEMAKA) Is Using Debt Extensively

Warren Buffett famously said, '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, Nemak, S. A. B. de C. V. (BMV:NEMAKA) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt 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?

You can click the graphic below for the historical numbers, but it shows that Nemak S. A. B. de C. V had Mex$30.0b of debt in March 2022, down from Mex$39.4b, one year before. However, it also had Mex$6.73b in cash, and so its net debt is Mex$23.3b.

A Look At Nemak S. A. B. de C. V's Liabilities

We can see from the most recent balance sheet that Nemak S. A. B. de C. V had liabilities of Mex$37.7b falling due within a year, and liabilities of Mex$31.0b due beyond that. Offsetting these obligations, it had cash of Mex$6.73b as well as receivables valued at Mex$12.5b due within 12 months. So its liabilities total Mex$49.5b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the Mex$13.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Nemak S. A. B. de C. V would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Nemak S. A. B. de C. V's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 2.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Nemak S. A. B. de C. V improved its EBIT by 6.2% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Nemak S. A. B. de C. V produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Mulling over Nemak S. A. B. de C. V's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Nemak S. A. B. de C. V's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 example, we've discovered 2 warning signs for Nemak S. A. B. de C. V (1 shouldn't be ignored!) that you should be aware of before investing here.

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.