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

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. 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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

The image below, which you can click on for greater detail, shows that at June 2024 Megacable Holdings S. A. B. de C. V had debt of Mex$25.7b, up from Mex$18.6b in one year. However, it does have Mex$4.60b in cash offsetting this, leading to net debt of about Mex$21.1b.

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

We can see from the most recent balance sheet that Megacable Holdings S. A. B. de C. V had liabilities of Mex$12.8b falling due within a year, and liabilities of Mex$25.3b due beyond that. On the other hand, it had cash of Mex$4.60b and Mex$3.84b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$29.6b.

This is a mountain of leverage relative to its market capitalization of Mex$36.2b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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 has net debt worth 1.6 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.8 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Importantly Megacable Holdings S. A. B. de C. V's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Megacable Holdings S. A. B. de C. V'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 we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Megacable Holdings S. A. B. de C. V actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Mulling over Megacable Holdings S. A. B. de C. V's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. 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 everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. For instance, we've identified 2 warning signs for Megacable Holdings S. A. B. de C. V that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.