Consorcio ARA S. A. B. de C. V (BMV:ARA) Seems To Use Debt Quite Sensibly

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 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. As with many other companies Consorcio ARA, S. A. B. de C. V. (BMV:ARA) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

View our latest analysis for Consorcio ARA S. A. B. de C. V

What Is Consorcio ARA S. A. B. de C. V's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Consorcio ARA S. A. B. de C. V had debt of Mex$1.90b, up from Mex$1.39b in one year. However, its balance sheet shows it holds Mex$2.95b in cash, so it actually has Mex$1.05b net cash.

A Look At Consorcio ARA S. A. B. de C. V's Liabilities

We can see from the most recent balance sheet that Consorcio ARA S. A. B. de C. V had liabilities of Mex$2.10b falling due within a year, and liabilities of Mex$5.19b due beyond that. Offsetting this, it had Mex$2.95b in cash and Mex$1.15b in receivables that were due within 12 months. So its liabilities total Mex$3.19b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of Mex$4.52b, so it does suggest shareholders should keep an eye on Consorcio ARA S. A. B. de C. V's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Consorcio ARA S. A. B. de C. V also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Consorcio ARA S. A. B. de C. V saw its EBIT decline by 2.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Consorcio ARA S. A. B. de C. V can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Consorcio ARA S. A. B. de C. V has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Consorcio ARA S. A. B. de C. V actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Consorcio ARA S. A. B. de C. V does have more liabilities than liquid assets, it also has net cash of Mex$1.05b. And it impressed us with free cash flow of Mex$347m, being 136% of its EBIT. So we are not troubled with Consorcio ARA S. A. B. de C. V's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Consorcio ARA S. A. B. de C. V you should know about.

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. 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.