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 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, Grupo Bafar, S.A.B. de C.V. (BMV:BAFARB) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Grupo Bafar. de
How Much Debt Does Grupo Bafar. de Carry?
As you can see below, Grupo Bafar. de had Mex$7.86b of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have Mex$437.7m in cash offsetting this, leading to net debt of about Mex$7.42b.
How Strong Is Grupo Bafar. de's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Grupo Bafar. de had liabilities of Mex$4.34b due within 12 months and liabilities of Mex$6.17b due beyond that. Offsetting these obligations, it had cash of Mex$437.7m as well as receivables valued at Mex$2.92b due within 12 months. So it has liabilities totalling Mex$7.15b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Grupo Bafar. de has a market capitalization of Mex$12.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Grupo Bafar. de's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Also relevant is that Grupo Bafar. de has grown its EBIT by a very respectable 24% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Grupo Bafar. de can strengthen its balance sheet over time. 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, Grupo Bafar. de recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Our View
Grupo Bafar. de's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. Taking the abovementioned factors together we do think Grupo Bafar. de's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Grupo Bafar. de you should know about.
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. 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.
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About BMV:BAFAR B
Grupo Bafar. de
Grupo Bafar, S.A.B. de C.V. produces and sells food products in Mexico and internationally.
Outstanding track record with mediocre balance sheet.
