Alfa. de (BMV:ALFAA) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Alfa S.A.B. de C.V. (BMV:ALFAA) makes use of debt. But is this debt a concern to shareholders?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alfa. de

How Much Debt Does Alfa. de Carry?

As you can see below, Alfa. de had Mex$108.5b of debt at December 2022, down from Mex$120.5b a year prior. However, it does have Mex$21.8b in cash offsetting this, leading to net debt of about Mex$86.7b.

How Strong Is Alfa. de's Balance Sheet?

According to the last reported balance sheet, Alfa. de had liabilities of Mex$99.8b due within 12 months, and liabilities of Mex$117.9b due beyond 12 months. On the other hand, it had cash of Mex$21.8b and Mex$35.3b worth of receivables due within a year. So it has liabilities totalling Mex$160.5b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the Mex$56.8b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Alfa. de 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). 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).

Alfa. de has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.8 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. One way Alfa. de could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 15%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alfa. de can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Alfa. de produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Alfa. de's struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its conversion of EBIT to free cash flow was refreshing. Looking at all the angles mentioned above, it does seem to us that Alfa. de is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Alfa. de is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...

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.