These 4 Measures Indicate That Corporativo Fragua. de (BMV:FRAGUAB) Is Using Debt Safely

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.' 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 can see that Corporativo Fragua, S.A.B. de C.V. (BMV:FRAGUAB) does use debt in its business. 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Corporativo Fragua. de

What Is Corporativo Fragua. de's Debt?

You can click the graphic below for the historical numbers, but it shows that Corporativo Fragua. de had Mex$1.69b of debt in December 2022, down from Mex$2.11b, one year before. However, it does have Mex$7.79b in cash offsetting this, leading to net cash of Mex$6.10b.

A Look At Corporativo Fragua. de's Liabilities

The latest balance sheet data shows that Corporativo Fragua. de had liabilities of Mex$21.9b due within a year, and liabilities of Mex$2.51b falling due after that. Offsetting this, it had Mex$7.79b in cash and Mex$1.77b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$14.8b.

Corporativo Fragua. de has a market capitalization of Mex$48.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Corporativo Fragua. de boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Corporativo Fragua. de grew its EBIT by 125% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Corporativo Fragua. de will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Corporativo Fragua. de has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Corporativo Fragua. de recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Corporativo Fragua. de's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of Mex$6.10b. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in Mex$5.6b. So is Corporativo Fragua. de's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Corporativo Fragua. de .

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. 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.