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 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. As with many other companies Grupo México, S.A.B. de C.V. (BMV:GMEXICOB) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Grupo México. de
What Is Grupo México. de's Debt?
As you can see below, Grupo México. de had US$8.80b of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$6.02b in cash leading to net debt of about US$2.79b.
How Healthy Is Grupo México. de's Balance Sheet?
The latest balance sheet data shows that Grupo México. de had liabilities of US$2.26b due within a year, and liabilities of US$11.5b falling due after that. Offsetting this, it had US$6.02b in cash and US$2.43b in receivables that were due within 12 months. So its liabilities total US$5.35b more than the combination of its cash and short-term receivables.
Given Grupo México. de has a humongous market capitalization of US$36.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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.
Grupo México. de has a low net debt to EBITDA ratio of only 0.35. And its EBIT covers its interest expense a whopping 12.5 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Grupo México. de grew its EBIT by 135% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 México. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Grupo México. de produced sturdy free cash flow equating to 60% 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, Grupo México. de's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Grupo México. de seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Grupo México. de (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.
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:GMEXICO B
Grupo México. de
Engages in copper production, cargo transportation, and infrastructure businesses worldwide.
Flawless balance sheet average dividend payer.
