Is Grupo Gigante S. A. B. de C. V (BMV:GIGANTE) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Grupo Gigante, S. A. B. de C. V. (BMV:GIGANTE) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Grupo Gigante S. A. B. de C. V

What Is Grupo Gigante S. A. B. de C. V's Debt?

The chart below, which you can click on for greater detail, shows that Grupo Gigante S. A. B. de C. V had Mex$11.2b in debt in March 2021; about the same as the year before. However, it also had Mex$3.49b in cash, and so its net debt is Mex$7.69b.

How Strong Is Grupo Gigante S. A. B. de C. V's Balance Sheet?

According to the last reported balance sheet, Grupo Gigante S. A. B. de C. V had liabilities of Mex$10.3b due within 12 months, and liabilities of Mex$15.2b due beyond 12 months. Offsetting this, it had Mex$3.49b in cash and Mex$3.00b in receivables that were due within 12 months. So its liabilities total Mex$19.0b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of Mex$20.9b, so it does suggest shareholders should keep an eye on Grupo Gigante S. A. B. de C. V's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Grupo Gigante S. A. B. de C. V shareholders face the double whammy of a high net debt to EBITDA ratio (7.1), and fairly weak interest coverage, since EBIT is just 0.048 times the interest expense. The debt burden here is substantial. Even worse, Grupo Gigante S. A. B. de C. V saw its EBIT tank 97% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Grupo Gigante S. A. B. de C. V'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 it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Grupo Gigante S. A. B. de C. V actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Grupo Gigante S. A. B. de C. V's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Grupo Gigante S. A. B. de C. V's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Grupo Gigante S. A. B. de C. V you should know about.

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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