We Think Grupo Pochteca. de (BMV:POCHTECB) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Grupo Pochteca, S.A.B. de C.V. (BMV:POCHTECB) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Grupo Pochteca. de

How Much Debt Does Grupo Pochteca. de Carry?

The image below, which you can click on for greater detail, shows that at June 2021 Grupo Pochteca. de had debt of Mex$1.15b, up from Mex$771.3m in one year. However, it does have Mex$389.2m in cash offsetting this, leading to net debt of about Mex$765.0m.

A Look At Grupo Pochteca. de's Liabilities

According to the last reported balance sheet, Grupo Pochteca. de had liabilities of Mex$2.43b due within 12 months, and liabilities of Mex$1.34b due beyond 12 months. Offsetting these obligations, it had cash of Mex$389.2m as well as receivables valued at Mex$1.43b due within 12 months. So its liabilities total Mex$1.94b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the Mex$913.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Grupo Pochteca. de 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.

Even though Grupo Pochteca. de's debt is only 2.0, its interest cover is really very low at 1.6. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Grupo Pochteca. de grew its EBIT by 6.5% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Grupo Pochteca. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Grupo Pochteca. de actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Grupo Pochteca. de's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Grupo Pochteca. de's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Grupo Pochteca. de you should be aware of, and 1 of them can't be ignored.

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.

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.

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