These 4 Measures Indicate That ALPEK. de (BMV:ALPEKA) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that ALPEK, S.A.B. de C.V. (BMV:ALPEKA) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ALPEK. de

What Is ALPEK. de's Net Debt?

As you can see below, ALPEK. de had Mex$30.9b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it also had Mex$8.35b in cash, and so its net debt is Mex$22.5b.

How Strong Is ALPEK. de's Balance Sheet?

We can see from the most recent balance sheet that ALPEK. de had liabilities of Mex$35.9b falling due within a year, and liabilities of Mex$37.9b due beyond that. Offsetting this, it had Mex$8.35b in cash and Mex$26.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$38.9b.

This is a mountain of leverage relative to its market capitalization of Mex$58.0b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ALPEK. de has a low net debt to EBITDA ratio of only 0.91. And its EBIT easily covers its interest expense, being 14.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, ALPEK. de grew its EBIT by 94% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if ALPEK. 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 always check how much of that EBIT is translated into free cash flow. During the last three years, ALPEK. de produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that ALPEK. de's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. When we consider the range of factors above, it looks like ALPEK. de is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that ALPEK. de is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.