Is Genomma Lab Internacional. de (BMV:LABB) Using Too Much Debt?

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. Importantly, Genomma Lab Internacional, S.A.B. de C.V. (BMV:LABB) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Genomma Lab Internacional. de

How Much Debt Does Genomma Lab Internacional. de Carry?

As you can see below, at the end of December 2022, Genomma Lab Internacional. de had Mex$6.38b of debt, up from Mex$5.90b a year ago. Click the image for more detail. However, because it has a cash reserve of Mex$1.50b, its net debt is less, at about Mex$4.87b.

How Healthy Is Genomma Lab Internacional. de's Balance Sheet?

We can see from the most recent balance sheet that Genomma Lab Internacional. de had liabilities of Mex$9.50b falling due within a year, and liabilities of Mex$2.09b due beyond that. Offsetting this, it had Mex$1.50b in cash and Mex$6.78b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$3.30b.

This deficit isn't so bad because Genomma Lab Internacional. de is worth Mex$14.5b, 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).

Genomma Lab Internacional. de has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.0 times the interest expense over the last year. Fortunately, Genomma Lab Internacional. de grew its EBIT by 6.8% in the last year, making that debt load look even more manageable. 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 Genomma Lab Internacional. de 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Genomma Lab Internacional. de's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Genomma Lab Internacional. de's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its conversion of EBIT to free cash flow makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Genomma Lab Internacional. de is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Genomma Lab Internacional. de you should be aware of.

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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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.