We Think Grupo Gigante S. A. B. de C. V (BMV:GIGANTE) Can Stay On Top Of Its 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.' 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. Importantly, Grupo Gigante, S. A. B. de C. V. (BMV:GIGANTE) does carry debt. 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. 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, 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

What Is Grupo Gigante S. A. B. de C. V's Debt?

The chart below, which you can click on for greater detail, shows that Grupo Gigante S. A. B. de C. V had Mex$10.3b in debt in March 2024; about the same as the year before. However, it also had Mex$4.39b in cash, and so its net debt is Mex$5.93b.

How Strong Is Grupo Gigante S. A. B. de C. V's Balance Sheet?

According to the last reported balance sheet, Grupo Gigante S. A. B. de C. V had liabilities of Mex$7.97b due within 12 months, and liabilities of Mex$18.1b due beyond 12 months. Offsetting these obligations, it had cash of Mex$4.39b as well as receivables valued at Mex$3.29b due within 12 months. So its liabilities total Mex$18.4b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of Mex$29.7b, so it does suggest shareholders should keep an eye on Grupo Gigante 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Grupo Gigante S. A. B. de C. V's low debt to EBITDA ratio of 0.99 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.3 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It is well worth noting that Grupo Gigante S. A. B. de C. V's EBIT shot up like bamboo after rain, gaining 79% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Grupo Gigante S. A. B. de C. V's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Grupo Gigante S. A. B. de C. V generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Grupo Gigante S. A. B. de C. V's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. When we consider the range of factors above, it looks like Grupo Gigante S. A. B. de C. V is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. We've identified 2 warning signs with Grupo Gigante S. A. B. de C. V (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com