We Think Organización Soriana S. A. B. de C. V (BMV:SORIANAB) Is Taking Some Risk With Its Debt

Warren Buffett famously said, '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. Importantly, Organización Soriana, S. A. B. de C. V. (BMV:SORIANAB) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

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

How Much Debt Does Organización Soriana S. A. B. de C. V Carry?

The chart below, which you can click on for greater detail, shows that Organización Soriana S. A. B. de C. V had Mex$12.6b in debt in June 2023; about the same as the year before. On the flip side, it has Mex$4.83b in cash leading to net debt of about Mex$7.74b.

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

Zooming in on the latest balance sheet data, we can see that Organización Soriana S. A. B. de C. V had liabilities of Mex$39.5b due within 12 months and liabilities of Mex$33.5b due beyond that. Offsetting this, it had Mex$4.83b in cash and Mex$5.77b in receivables that were due within 12 months. So it has liabilities totalling Mex$62.4b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of Mex$46.8b, 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. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 0.65 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly Organización Soriana S. A. B. de C. V's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Organización Soriana S. A. B. de C. V recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Neither Organización Soriana S. A. B. de C. V's ability to handle its total liabilities nor its interest cover 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. We think that Organización Soriana S. A. B. de C. V's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Over time, share prices tend to follow earnings per share, so if you're interested in Organización Soriana S. A. B. de C. V, you may well want to click here to check an interactive graph of its earnings per share history.

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.