Is Industrias Peñoles. de (BMV:PE&OLES) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Industrias Peñoles, S.A.B. de C.V. (BMV:PE&OLES) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Industrias Peñoles. de

How Much Debt Does Industrias Peñoles. de Carry?

The chart below, which you can click on for greater detail, shows that Industrias Peñoles. de had US$3.05b in debt in September 2022; about the same as the year before. However, it does have US$1.69b in cash offsetting this, leading to net debt of about US$1.36b.

How Healthy Is Industrias Peñoles. de's Balance Sheet?

According to the last reported balance sheet, Industrias Peñoles. de had liabilities of US$1.24b due within 12 months, and liabilities of US$3.66b due beyond 12 months. Offsetting this, it had US$1.69b in cash and US$558.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.65b.

This deficit isn't so bad because Industrias Peñoles. de is worth US$6.01b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

While Industrias Peñoles. de's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.0 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, Industrias Peñoles. de's EBIT fell a jaw-dropping 52% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Industrias Peñoles. de's ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Industrias Peñoles. de recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Industrias Peñoles. de's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Industrias Peñoles. de stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. To that end, you should learn about the 2 warning signs we've spotted with Industrias Peñoles. de (including 1 which is potentially serious) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.