Megacable Holdings S. A. B. de C. V (BMV:MEGACPO) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, '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. We note that Megacable Holdings, S. A. B. de C. V. (BMV:MEGACPO) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

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

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

As you can see below, at the end of June 2023, Megacable Holdings S. A. B. de C. V had Mex$18.6b of debt, up from Mex$9.22b a year ago. Click the image for more detail. However, it also had Mex$1.21b in cash, and so its net debt is Mex$17.4b.

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

According to the last reported balance sheet, Megacable Holdings S. A. B. de C. V had liabilities of Mex$7.14b due within 12 months, and liabilities of Mex$22.5b due beyond 12 months. On the other hand, it had cash of Mex$1.21b and Mex$3.91b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$24.5b.

This deficit is considerable relative to its market capitalization of Mex$35.8b, so it does suggest shareholders should keep an eye on Megacable Holdings S. A. B. de C. V's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Megacable Holdings S. A. B. de C. V has net debt worth 1.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.8 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Unfortunately, Megacable Holdings S. A. B. de C. V saw its EBIT slide 8.0% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. 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. Over the last three years, Megacable Holdings S. A. B. de C. V reported free cash flow worth 18% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On this analysis Megacable Holdings S. A. B. de C. V's conversion of EBIT to free cash flow and EBIT growth rate both make us a little nervous. But the good news is that its solid net debt to EBITDA gives us reason for some optimism. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Megacable Holdings S. A. B. de C. V stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For example, we've discovered 2 warning signs for Megacable Holdings S. A. B. de C. V that you should be aware of before investing here.

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.

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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.