Is El Puerto de Liverpool. de (BMV:LIVEPOLC-1) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that El Puerto de Liverpool, S.A.B. de C.V. (BMV:LIVEPOLC-1) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for El Puerto de Liverpool. de

How Much Debt Does El Puerto de Liverpool. de Carry?

You can click the graphic below for the historical numbers, but it shows that El Puerto de Liverpool. de had Mex$30.5b of debt in September 2022, down from Mex$34.9b, one year before. However, it also had Mex$13.2b in cash, and so its net debt is Mex$17.3b.

A Look At El Puerto de Liverpool. de's Liabilities

The latest balance sheet data shows that El Puerto de Liverpool. de had liabilities of Mex$43.6b due within a year, and liabilities of Mex$49.4b falling due after that. On the other hand, it had cash of Mex$13.2b and Mex$32.6b worth of receivables due within a year. So its liabilities total Mex$47.3b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since El Puerto de Liverpool. de has a market capitalization of Mex$162.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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.

El Puerto de Liverpool. de's net debt is only 0.65 times its EBITDA. And its EBIT easily covers its interest expense, being 10.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that El Puerto de Liverpool. de has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine El Puerto de Liverpool. de'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. Over the last three years, El Puerto de Liverpool. de recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

El Puerto de Liverpool. de's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think El Puerto de Liverpool. de is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. Over time, share prices tend to follow earnings per share, so if you're interested in El Puerto de Liverpool. de, you may well want to click here to check an interactive graph of its earnings per share history.

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.