Here's Why Megacable Holdings S. A. B. de C. V (BMV:MEGACPO) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Megacable Holdings, S. A. B. de C. V. (BMV:MEGACPO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Megacable Holdings S. A. B. de C. V

What Is Megacable Holdings S. A. B. de C. V's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Megacable Holdings S. A. B. de C. V had debt of Mex$9.22b, up from Mex$6.92b in one year. However, it also had Mex$1.77b in cash, and so its net debt is Mex$7.45b.

A Look At Megacable Holdings S. A. B. de C. V's Liabilities

Zooming in on the latest balance sheet data, we can see that Megacable Holdings S. A. B. de C. V had liabilities of Mex$11.8b due within 12 months and liabilities of Mex$8.06b due beyond that. Offsetting these obligations, it had cash of Mex$1.77b as well as receivables valued at Mex$3.10b due within 12 months. So its liabilities total Mex$15.0b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Megacable Holdings S. A. B. de C. V is worth Mex$38.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Megacable Holdings S. A. B. de C. V has a low net debt to EBITDA ratio of only 0.66. And its EBIT covers its interest expense a whopping 18.7 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Megacable Holdings S. A. B. de C. V grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. 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 Megacable Holdings S. A. B. de C. V 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. In the last three years, Megacable Holdings S. A. B. de C. V's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Megacable Holdings S. A. B. de C. V's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Considering this range of data points, we think Megacable Holdings S. A. B. de C. V is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 example, we've discovered 1 warning sign for Megacable Holdings S. A. B. de C. V that you should be aware of before investing here.

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.