Is Industrias Peñoles. de (BMV:PE&OLES) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Industrias Peñoles, S.A.B. de C.V. (BMV:PE&OLES) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Industrias Peñoles. de

What Is Industrias Peñoles. de's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Industrias Peñoles. de had debt of US$3.20b, up from US$2.93b in one year. However, because it has a cash reserve of US$1.81b, its net debt is less, at about US$1.39b.

A Look At Industrias Peñoles. de's Liabilities

According to the last reported balance sheet, Industrias Peñoles. de had liabilities of US$1.38b due within 12 months, and liabilities of US$3.67b due beyond 12 months. On the other hand, it had cash of US$1.81b and US$695.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.54b.

This deficit is considerable relative to its market capitalization of US$3.75b, so it does suggest shareholders should keep an eye on Industrias Peñoles. de's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Industrias Peñoles. de has net debt of just 0.87 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.3 times the interest expense over the last year. And we also note warmly that Industrias Peñoles. de grew its EBIT by 10% last year, making its debt load easier to handle. 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 Industrias Peñoles. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Industrias Peñoles. de recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Even if we have reservations about how easily Industrias Peñoles. de is capable of staying on top of its total liabilities, its net debt to EBITDA and EBIT growth rate make us think feel relatively unconcerned. We think that Industrias Peñoles. de's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For instance, we've identified 2 warning signs for Industrias Peñoles. de that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.