Farmacias Benavides. de (BMV:BEVIDESB) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Farmacias Benavides, S.A.B. de C.V. (BMV:BEVIDESB) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Farmacias Benavides. de

How Much Debt Does Farmacias Benavides. de Carry?

The chart below, which you can click on for greater detail, shows that Farmacias Benavides. de had Mex$1.10b in debt in June 2024; about the same as the year before. On the flip side, it has Mex$451.3m in cash leading to net debt of about Mex$652.2m.

A Look At Farmacias Benavides. de's Liabilities

Zooming in on the latest balance sheet data, we can see that Farmacias Benavides. de had liabilities of Mex$4.58b due within 12 months and liabilities of Mex$3.34b due beyond that. On the other hand, it had cash of Mex$451.3m and Mex$943.6m worth of receivables due within a year. So its liabilities total Mex$6.53b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of Mex$8.59b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 0.35 times EBITDA, it is initially surprising to see that Farmacias Benavides. de's EBIT has low interest coverage of 1.9 times. So one way or the other, it's clear the debt levels are not trivial. Farmacias Benavides. de grew its EBIT by 2.3% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Farmacias Benavides. de's earnings that will influence how the balance sheet holds up in the future. 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 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. Over the last three years, Farmacias Benavides. de actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Farmacias Benavides. de's conversion of EBIT to free cash flow was a real positive on this analysis, as was its net debt to EBITDA. But truth be told its interest cover had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about Farmacias Benavides. de's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Farmacias Benavides. de (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.