We Think Organización Soriana S. A. B. de C. V (BMV:SORIANAB) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Organización Soriana, S. A. B. de C. V. (BMV:SORIANAB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View 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$13.8b at the end of September 2022, a reduction from Mex$18.2b over a year. On the flip side, it has Mex$1.90b in cash leading to net debt of about Mex$11.9b.

A Look At Organización Soriana S. A. B. de C. V's Liabilities

The latest balance sheet data shows that Organización Soriana S. A. B. de C. V had liabilities of Mex$26.5b due within a year, and liabilities of Mex$35.8b falling due after that. Offsetting this, it had Mex$1.90b in cash and Mex$5.03b in receivables that were due within 12 months. So it has liabilities totalling Mex$55.3b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of Mex$55.6b, so it does suggest shareholders should keep an eye on Organización Soriana 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). 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 1.0 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Organización Soriana S. A. B. de C. V grew its EBIT by 2.2% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Organización Soriana S. A. B. de C. V actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

When it comes to the balance sheet, the standout positive for Organización Soriana S. A. B. de C. V was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Looking at all this data makes us feel a little cautious about Organización Soriana S. A. B. de C. V's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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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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.