Is Grupo Cementos de Chihuahua. de (BMV:GCC) Using Too Much Debt?

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.' 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 Grupo Cementos de Chihuahua, S.A.B. de C.V. (BMV:GCC) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Grupo Cementos de Chihuahua. de

What Is Grupo Cementos de Chihuahua. de's Net Debt?

As you can see below, Grupo Cementos de Chihuahua. de had US$628.9m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$562.1m, its net debt is less, at about US$66.7m.

A Look At Grupo Cementos de Chihuahua. de's Liabilities

We can see from the most recent balance sheet that Grupo Cementos de Chihuahua. de had liabilities of US$296.1m falling due within a year, and liabilities of US$669.2m due beyond that. Offsetting these obligations, it had cash of US$562.1m as well as receivables valued at US$124.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$278.3m.

Since publicly traded Grupo Cementos de Chihuahua. de shares are worth a total of US$2.10b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.23 and interest cover of 6.4 times, it seems to us that Grupo Cementos de Chihuahua. de is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Fortunately, Grupo Cementos de Chihuahua. de grew its EBIT by 2.8% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Grupo Cementos de Chihuahua. de can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 Cementos de Chihuahua. de actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Grupo Cementos de Chihuahua. de's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Grupo Cementos de Chihuahua. de seems to use debt quite reasonably; and that gets the nod from us. 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. For instance, we've identified 1 warning sign for Grupo Cementos de Chihuahua. de that you should be aware of.

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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