Does Grupo Mexicano de Desarrollo (BMV:GMD) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Grupo Mexicano de Desarrollo, S.A.B. (BMV:GMD) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Grupo Mexicano de Desarrollo

How Much Debt Does Grupo Mexicano de Desarrollo Carry?

The image below, which you can click on for greater detail, shows that Grupo Mexicano de Desarrollo had debt of Mex$2.58b at the end of March 2021, a reduction from Mex$2.84b over a year. However, because it has a cash reserve of Mex$506.5m, its net debt is less, at about Mex$2.08b.

How Strong Is Grupo Mexicano de Desarrollo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Grupo Mexicano de Desarrollo had liabilities of Mex$895.1m due within 12 months and liabilities of Mex$3.12b due beyond that. On the other hand, it had cash of Mex$506.5m and Mex$829.4m worth of receivables due within a year. So its liabilities total Mex$2.68b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of Mex$2.76b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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

Grupo Mexicano de Desarrollo's net debt is sitting at a very reasonable 2.5 times its EBITDA, while its EBIT covered its interest expense just 5.0 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Shareholders should be aware that Grupo Mexicano de Desarrollo's EBIT was down 52% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Grupo Mexicano de Desarrollo will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Grupo Mexicano de Desarrollo recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Grupo Mexicano de Desarrollo's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least its interest cover is not so bad. We're quite clear that we consider Grupo Mexicano de Desarrollo to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Grupo Mexicano de Desarrollo that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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