Kimberly-Clark de México S. A. B. de C. V (BMV:KIMBERA) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Kimberly-Clark de México, S. A. B. de C. V. (BMV:KIMBERA) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. 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 Kimberly-Clark de México S. A. B. de C. V

How Much Debt Does Kimberly-Clark de México S. A. B. de C. V Carry?

The image below, which you can click on for greater detail, shows that Kimberly-Clark de México S. A. B. de C. V had debt of Mex$28.5b at the end of December 2021, a reduction from Mex$32.7b over a year. However, it also had Mex$12.3b in cash, and so its net debt is Mex$16.3b.

How Healthy Is Kimberly-Clark de México S. A. B. de C. V's Balance Sheet?

The latest balance sheet data shows that Kimberly-Clark de México S. A. B. de C. V had liabilities of Mex$15.3b due within a year, and liabilities of Mex$27.8b falling due after that. Offsetting this, it had Mex$12.3b in cash and Mex$6.71b in receivables that were due within 12 months. So its liabilities total Mex$24.1b more than the combination of its cash and short-term receivables.

Kimberly-Clark de México S. A. B. de C. V has a market capitalization of Mex$81.6b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Kimberly-Clark de México S. A. B. de C. V's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 4.7 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Kimberly-Clark de México S. A. B. de C. V's EBIT fell a jaw-dropping 21% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Kimberly-Clark de México S. A. B. de C. V 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, a company can only pay off debt with cold hard cash, not accounting profits. 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, Kimberly-Clark de México S. A. B. de C. V generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Kimberly-Clark de México S. A. B. de C. V's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Kimberly-Clark de México S. A. B. de C. V's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Kimberly-Clark de México S. A. B. de C. V is showing 2 warning signs in our investment analysis , 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. 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.