Stock Analysis

We Think Megacable Holdings S. A. B. de C. V (BMV:MEGACPO) Is Taking Some Risk With Its Debt

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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Megacable Holdings, S. A. B. de C. V. (BMV:MEGACPO) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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 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 Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Megacable Holdings S. A. B. de C. V had debt of Mex$13.7b, up from Mex$6.38b in one year. However, it does have Mex$1.38b in cash offsetting this, leading to net debt of about Mex$12.4b.

BMV:MEGA CPO Debt to Equity History March 17th 2023

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

Zooming in on the latest balance sheet data, we can see that Megacable Holdings S. A. B. de C. V had liabilities of Mex$8.94b due within 12 months and liabilities of Mex$15.0b due beyond that. Offsetting these obligations, it had cash of Mex$1.38b as well as receivables valued at Mex$3.58b due within 12 months. So it has liabilities totalling Mex$19.0b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Megacable Holdings S. A. B. de C. V is worth Mex$40.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). 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).

Looking at its net debt to EBITDA of 0.97 and interest cover of 5.0 times, it seems to us that Megacable Holdings S. A. B. de C. V is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Unfortunately, Megacable Holdings S. A. B. de C. V saw its EBIT slide 4.9% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Megacable Holdings S. A. B. de C. V's free cash flow amounted to 24% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Megacable Holdings S. A. B. de C. V's conversion of EBIT to free cash flow and EBIT growth rate definitely weigh on it, in our esteem. But it seems to be able handle its debt, based on its EBITDA, without much trouble. When we consider all the factors discussed, it seems to us that Megacable Holdings S. A. B. de C. V is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Megacable Holdings S. A. B. de C. V .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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Find out whether Megacable Holdings S. A. B. de C. V is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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