Is Organización Soriana S. A. B. de C. V (BMV:SORIANAB) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Organización Soriana, S. A. B. de C. V. (BMV:SORIANAB) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt 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 Net 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$22.0b at the end of March 2021, a reduction from Mex$27.0b over a year. However, it does have Mex$3.59b in cash offsetting this, leading to net debt of about Mex$18.5b.

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

The latest balance sheet data shows that Organización Soriana S. A. B. de C. V had liabilities of Mex$33.3b due within a year, and liabilities of Mex$36.9b falling due after that. Offsetting these obligations, it had cash of Mex$3.59b as well as receivables valued at Mex$8.01b due within 12 months. So it has liabilities totalling Mex$58.6b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the Mex$33.0b 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'd watch its balance sheet closely, without a doubt. At the end of the day, Organización Soriana S. A. B. de C. V 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Organización Soriana S. A. B. de C. V has net debt worth 1.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.6 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Sadly, Organización Soriana S. A. B. de C. V's EBIT actually dropped 5.4% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Organización Soriana S. A. B. de C. V recorded free cash flow worth 65% 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

We'd go so far as to say Organización Soriana S. A. B. de C. V's level of total liabilities was disappointing. 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 Organización Soriana S. A. B. de C. V's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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 Organización Soriana S. A. B. de C. V'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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