Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Grupo Rotoplas S.A.B. de C.V. (BMV:AGUA) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Grupo Rotoplas. de
How Much Debt Does Grupo Rotoplas. de Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Grupo Rotoplas. de had Mex$4.15b of debt, an increase on Mex$2.98b, over one year. However, it does have Mex$3.39b in cash offsetting this, leading to net debt of about Mex$756.6m.
How Strong Is Grupo Rotoplas. de's Balance Sheet?
According to the last reported balance sheet, Grupo Rotoplas. de had liabilities of Mex$1.84b due within 12 months, and liabilities of Mex$4.69b due beyond 12 months. Offsetting these obligations, it had cash of Mex$3.39b as well as receivables valued at Mex$2.00b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$1.14b.
Since publicly traded Grupo Rotoplas. de shares are worth a total of Mex$10.9b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). 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).
Looking at its net debt to EBITDA of 0.55 and interest cover of 4.1 times, it seems to us that Grupo Rotoplas. de is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably Grupo Rotoplas. de's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Grupo Rotoplas. de's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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. During the last three years, Grupo Rotoplas. de produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
Grupo Rotoplas. de's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its interest cover does undermine this impression a bit. Taking all this data into account, it seems to us that Grupo Rotoplas. de takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. To that end, you should learn about the 3 warning signs we've spotted with Grupo Rotoplas. de (including 1 which makes us a bit uncomfortable) .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. 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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About BMV:AGUA *
Grupo Rotoplas. de
Manufactures, purchases, sells, and installs plastic containers and accessories for water storage, conduction, and improvement solutions in Mexico, Argentina, the United States and internationally.
Moderate with reasonable growth potential.
