We Think Consorcio ARA S. A. B. de C. V (BMV:ARA) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Consorcio ARA, S. A. B. de C. V. (BMV:ARA) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See 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?

You can click the graphic below for the historical numbers, but it shows that Consorcio ARA S. A. B. de C. V had Mex$2.18b of debt in December 2020, down from Mex$2.60b, one year before. But it also has Mex$3.10b in cash to offset that, meaning it has Mex$917.1m net cash.

How Healthy Is Consorcio ARA S. A. B. de C. V's Balance Sheet?

We can see from the most recent balance sheet that Consorcio ARA S. A. B. de C. V had liabilities of Mex$2.73b falling due within a year, and liabilities of Mex$4.27b due beyond that. Offsetting this, it had Mex$3.10b in cash and Mex$996.8m in receivables that were due within 12 months. So it has liabilities totalling Mex$2.90b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Consorcio ARA S. A. B. de C. V has a market capitalization of Mex$6.14b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Consorcio ARA S. A. B. de C. V boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Consorcio ARA S. A. B. de C. V's load is not too heavy, because its EBIT was down 44% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Consorcio ARA S. A. B. de C. V's ability to maintain a healthy balance sheet going forward. 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. Consorcio ARA S. A. B. de C. V may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Consorcio ARA S. A. B. de C. V 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.

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$917.1m. And it impressed us with free cash flow of Mex$903m, being 120% of its EBIT. So we don't have any problem with Consorcio ARA S. A. B. de C. V's use of debt. 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. For instance, we've identified 2 warning signs for Consorcio ARA S. A. B. de C. V that you should be aware of.

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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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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