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.' 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. As with many other companies Arca Continental, S.A.B. de C.V. (BMV:AC) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Arca Continental. de
How Much Debt Does Arca Continental. de Carry?
You can click the graphic below for the historical numbers, but it shows that Arca Continental. de had Mex$46.3b of debt in September 2023, down from Mex$49.2b, one year before. However, it also had Mex$27.3b in cash, and so its net debt is Mex$19.0b.
How Strong Is Arca Continental. de's Balance Sheet?
The latest balance sheet data shows that Arca Continental. de had liabilities of Mex$48.2b due within a year, and liabilities of Mex$58.2b falling due after that. Offsetting these obligations, it had cash of Mex$27.3b as well as receivables valued at Mex$19.3b due within 12 months. So it has liabilities totalling Mex$59.9b more than its cash and near-term receivables, combined.
Arca Continental. de has a very large market capitalization of Mex$294.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Arca Continental. de has a low net debt to EBITDA ratio of only 0.47. And its EBIT covers its interest expense a whopping 27.3 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Arca Continental. de grew its EBIT by 13% last year, making its debt load easier to handle. 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 Arca Continental. de'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Arca Continental. de produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
Happily, Arca Continental. de's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at the bigger picture, we think Arca Continental. de's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 1 warning sign for Arca Continental. de you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
About BMV:AC *
Arca Continental. de
Produces, distributes, and sells soft drinks in Mexico, Peru, the United States, Argentina, and Ecuador.
Very undervalued with excellent balance sheet and pays a dividend.
