These 4 Measures Indicate That Grupo Gigante S. A. B. de C. V (BMV:GIGANTE) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Grupo Gigante, S. A. B. de C. V. (BMV:GIGANTE) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, 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.

View our latest analysis for Grupo Gigante S. A. B. de C. V

How Much Debt Does Grupo Gigante S. A. B. de C. V Carry?

The image below, which you can click on for greater detail, shows that Grupo Gigante S. A. B. de C. V had debt of Mex$9.54b at the end of September 2023, a reduction from Mex$10.8b over a year. However, it also had Mex$3.75b in cash, and so its net debt is Mex$5.79b.

A Look At Grupo Gigante S. A. B. de C. V's Liabilities

According to the last reported balance sheet, Grupo Gigante S. A. B. de C. V had liabilities of Mex$8.34b due within 12 months, and liabilities of Mex$16.6b due beyond 12 months. Offsetting this, it had Mex$3.75b in cash and Mex$3.32b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$17.9b.

While this might seem like a lot, it is not so bad since Grupo Gigante S. A. B. de C. V has a market capitalization of Mex$31.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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).

Even though Grupo Gigante S. A. B. de C. V's debt is only 1.6, its interest cover is really very low at 1.9. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. Importantly Grupo Gigante S. A. B. de C. V's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Grupo Gigante S. A. B. de C. V will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Grupo Gigante S. A. B. de C. V actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On our analysis Grupo Gigante S. A. B. de C. V's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. Looking at all this data makes us feel a little cautious about Grupo Gigante S. A. B. de C. V's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Grupo Gigante S. A. B. de C. V you should know about.

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.