Is Grupo Comercial Chedraui. de (BMV:CHDRAUIB) A Risky Investment?

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. We can see that Grupo Comercial Chedraui, S.A.B. de C.V. (BMV:CHDRAUIB) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Grupo Comercial Chedraui. de

What Is Grupo Comercial Chedraui. de's Debt?

As you can see below, Grupo Comercial Chedraui. de had Mex$11.0b of debt at September 2020, down from Mex$12.7b a year prior. However, it does have Mex$2.93b in cash offsetting this, leading to net debt of about Mex$8.03b.

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

The latest balance sheet data shows that Grupo Comercial Chedraui. de had liabilities of Mex$23.7b due within a year, and liabilities of Mex$38.2b falling due after 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.

This deficit casts a shadow over the Mex$25.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Grupo Comercial Chedraui. de would probably need a major re-capitalization if its creditors were to demand repayment.

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).

Looking at its net debt to EBITDA of 1.0 and interest cover of 3.0 times, it seems to us that Grupo Comercial Chedraui. de is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We note that Grupo Comercial Chedraui. de grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. 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 Grupo Comercial Chedraui. de's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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, Grupo Comercial Chedraui. de produced sturdy free cash flow equating to 73% 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

Grupo Comercial Chedraui. de's level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its EBIT growth rate was re-invigorating. We think that Grupo Comercial Chedraui. de's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Grupo Comercial Chedraui. de's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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