Grupo Comercial Chedraui. de (BMV:CHDRAUIB) Takes On Some Risk With Its Use Of 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 Comercial Chedraui, S.A.B. de C.V. (BMV:CHDRAUIB) does carry debt. But is this debt a concern to shareholders?

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. 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. 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 Grupo Comercial Chedraui. de

How Much Debt Does Grupo Comercial Chedraui. de Carry?

The image below, which you can click on for greater detail, shows that Grupo Comercial Chedraui. de had debt of Mex$11.0b at the end of September 2020, a reduction from Mex$12.7b over a year. On the flip side, it has Mex$2.93b in cash leading to net debt of about Mex$8.03b.

How Healthy Is Grupo Comercial Chedraui. de's Balance Sheet?

We can see from the most recent balance sheet that Grupo Comercial Chedraui. de had liabilities of Mex$23.7b falling due within a year, and liabilities of Mex$38.2b due beyond that. Offsetting this, it had Mex$2.93b in cash and Mex$3.14b in receivables that were due within 12 months. So its liabilities total Mex$55.9b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the Mex$30.7b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Grupo Comercial Chedraui. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Grupo Comercial Chedraui. de's low debt to EBITDA ratio of 1.0 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Also relevant is that Grupo Comercial Chedraui. de has grown its EBIT by a very respectable 25% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Grupo Comercial Chedraui. de 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Grupo Comercial Chedraui. de recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Grupo Comercial Chedraui. de's struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its EBIT growth rate was refreshing. We think that Grupo Comercial Chedraui. de's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Over time, share prices tend to follow earnings per share, so if you're interested in Grupo Comercial Chedraui. de, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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