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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Megacable Holdings, S. A. B. de C. V. (BMV:MEGACPO) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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

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

As you can see below, at the end of December 2023, Megacable Holdings S. A. B. de C. V had Mex$20.9b of debt, up from Mex$13.7b a year ago. Click the image for more detail. However, it also had Mex$1.58b in cash, and so its net debt is Mex$19.3b.

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$21.3b falling due after that. On the other hand, it had cash of Mex$1.58b and Mex$3.83b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$27.1b.

This deficit is considerable relative to its market capitalization of Mex$42.1b, 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.

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.

Looking at its net debt to EBITDA of 1.4 and interest cover of 3.3 times, it seems to us that Megacable Holdings S. A. B. de C. V is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Unfortunately, Megacable Holdings S. A. B. de C. V saw its EBIT slide 4.6% 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. When analysing debt levels, the balance sheet is the obvious place to start. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Megacable Holdings S. A. B. de C. V recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

We'd go so far as to say Megacable Holdings S. A. B. de C. V's conversion of EBIT to free cash flow was disappointing. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Overall, we think it's fair to say that Megacable Holdings S. A. B. de C. V has enough debt that there are some real risks around the balance sheet. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Megacable Holdings S. A. B. de C. V (2 shouldn't be ignored!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.