Is Megacable Holdings S. A. B. de C. V (BMV:MEGACPO) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Megacable Holdings, S. A. B. de C. V. (BMV:MEGACPO) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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

How Much Debt Does Megacable Holdings S. A. B. de C. V Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Megacable Holdings S. A. B. de C. V had Mex$19.9b of debt, an increase on Mex$11.0b, over one year. However, because it has a cash reserve of Mex$1.76b, its net debt is less, at about Mex$18.2b.

How Strong Is Megacable Holdings S. A. B. de C. V's Balance Sheet?

The latest balance sheet data shows that Megacable Holdings S. A. B. de C. V had liabilities of Mex$11.2b due within a year, and liabilities of Mex$20.5b falling due after that. Offsetting these obligations, it had cash of Mex$1.76b as well as receivables valued at Mex$3.69b due within 12 months. So its liabilities total Mex$26.3b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of Mex$33.9b, so it does suggest shareholders should keep an eye on Megacable Holdings S. A. B. de C. V's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Megacable Holdings S. A. B. de C. V's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 3.4 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. The bad news is that Megacable Holdings S. A. B. de C. V saw its EBIT decline by 11% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. 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're focused on the future you can check out this free report showing analyst profit forecasts.

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 created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Megacable Holdings S. A. B. de C. V's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. Looking at the bigger picture, it seems clear to us that Megacable Holdings S. A. B. de C. V's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. We've identified 3 warning signs with Megacable Holdings S. A. B. de C. V (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.