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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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.

Why Does Debt Bring Risk?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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

What Is Nemak S. A. B. de C. V's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Nemak S. A. B. de C. V had debt of US$1.90b, up from US$1.73b in one year. On the flip side, it has US$266.4m in cash leading to net debt of about US$1.64b.

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 US$1.75b falling due within a year, and liabilities of US$1.98b due beyond that. Offsetting this, it had US$266.4m in cash and US$692.0m in receivables that were due within 12 months. So it has liabilities totalling US$2.77b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$361.1m 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.

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.

While Nemak S. A. B. de C. V's debt to EBITDA ratio (3.4) suggests that it uses some debt, its interest cover is very weak, at 1.9, 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. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Another concern for investors might be that Nemak S. A. B. de C. V's EBIT fell 15% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. 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 Nemak S. A. B. de C. V 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Nemak S. A. B. de C. V barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

To be frank both Nemak S. A. B. de C. V's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Nemak S. A. B. de C. V has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. 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 2 don't sit too well with us!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.