We Think Servicios Corporativos Javer. de (BMV:JAVER) 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.' 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. We note that Servicios Corporativos Javer, S.A.B. de C.V. (BMV:JAVER) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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

Check out our latest analysis for Servicios Corporativos Javer. de

What Is Servicios Corporativos Javer. de's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Servicios Corporativos Javer. de had Mex$3.06b of debt, an increase on Mex$2.37b, over one year. On the flip side, it has Mex$836.4m in cash leading to net debt of about Mex$2.23b.

A Look At Servicios Corporativos Javer. de's Liabilities

Zooming in on the latest balance sheet data, we can see that Servicios Corporativos Javer. de had liabilities of Mex$3.26b due within 12 months and liabilities of Mex$3.16b due beyond that. Offsetting this, it had Mex$836.4m in cash and Mex$765.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$4.81b.

Given this deficit is actually higher than the company's market capitalization of Mex$4.02b, we think shareholders really should watch Servicios Corporativos Javer. de's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 1.4 and interest cover of 3.4 times, it seems to us that Servicios Corporativos Javer. 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. Also relevant is that Servicios Corporativos Javer. de has grown its EBIT by a very respectable 26% in the last year, thus enhancing its ability to pay down debt. 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 Servicios Corporativos Javer. de'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Servicios Corporativos Javer. de produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both Servicios Corporativos Javer. de's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. Looking at all this data makes us feel a little cautious about Servicios Corporativos Javer. de's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. We've identified 3 warning signs with Servicios Corporativos Javer. de (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.