Here's Why Internacional de Cerámica. de (BMV:CERAMICB) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Internacional de Cerámica, S.A.B. de C.V. (BMV:CERAMICB) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Internacional de Cerámica. de

What Is Internacional de Cerámica. de's Net Debt?

As you can see below, Internacional de Cerámica. de had Mex$3.83b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has Mex$1.83b in cash leading to net debt of about Mex$1.99b.

How Strong Is Internacional de Cerámica. de's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Internacional de Cerámica. de had liabilities of Mex$2.47b due within 12 months and liabilities of Mex$4.86b due beyond that. Offsetting these obligations, it had cash of Mex$1.83b as well as receivables valued at Mex$1.03b due within 12 months. So its liabilities total Mex$4.46b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of Mex$6.58b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.1 and interest cover of 2.8 times, it seems to us that Internacional de Cerámica. 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. If Internacional de Cerámica. de can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Internacional de Cerámica. de will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. Happily for any shareholders, Internacional de Cerámica. de actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On our analysis Internacional de Cerámica. de's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. Considering this range of data points, we think Internacional de Cerámica. de is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 4 warning signs for Internacional de Cerámica. de (2 are a bit unpleasant!) that you should be aware of before investing here.

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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