Here's Why Organización Soriana S. A. B. de C. V (BMV:SORIANAB) Has A Meaningful Debt Burden

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Organización Soriana, S. A. B. de C. V. (BMV:SORIANAB) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for Organización Soriana S. A. B. de C. V

What Is Organización Soriana S. A. B. de C. V's Debt?

The image below, which you can click on for greater detail, shows that Organización Soriana S. A. B. de C. V had debt of Mex$18.2b at the end of September 2021, a reduction from Mex$25.5b over a year. However, because it has a cash reserve of Mex$2.79b, its net debt is less, at about Mex$15.4b.

How Healthy Is Organización Soriana S. A. B. de C. V's Balance Sheet?

According to the last reported balance sheet, Organización Soriana S. A. B. de C. V had liabilities of Mex$31.5b due within 12 months, and liabilities of Mex$36.4b due beyond 12 months. Offsetting this, it had Mex$2.79b in cash and Mex$7.43b in receivables that were due within 12 months. So it has liabilities totalling Mex$57.6b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of Mex$41.0b, we think shareholders really should watch Organización Soriana S. A. B. de C. V's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Organización Soriana S. A. B. de C. V's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.0 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Unfortunately, Organización Soriana S. A. B. de C. V saw its EBIT slide 2.3% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Organización Soriana S. A. B. de C. V'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Organización Soriana S. A. B. de C. V recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Neither Organización Soriana S. A. B. de C. V's ability to handle its total liabilities nor its EBIT growth rate gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Organización Soriana S. A. B. de C. V's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For example, we've discovered 1 warning sign for Organización Soriana S. A. B. de C. V that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.