Here's Why GMéxico Transportes. de (BMV:GMXT) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that GMéxico Transportes, S.A.B. de C.V. (BMV:GMXT) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for GMéxico Transportes. de

How Much Debt Does GMéxico Transportes. de Carry?

As you can see below, GMéxico Transportes. de had Mex$28.3b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of Mex$3.88b, its net debt is less, at about Mex$24.4b.

How Strong Is GMéxico Transportes. de's Balance Sheet?

We can see from the most recent balance sheet that GMéxico Transportes. de had liabilities of Mex$10.3b falling due within a year, and liabilities of Mex$43.7b due beyond that. Offsetting this, it had Mex$3.88b in cash and Mex$8.52b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$41.7b.

This deficit isn't so bad because GMéxico Transportes. de is worth Mex$122.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While GMéxico Transportes. de's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.8 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. GMéxico Transportes. de grew its EBIT by 3.3% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 GMéxico Transportes. 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 always check how much of that EBIT is translated into free cash flow. During the last three years, GMéxico Transportes. de produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, GMéxico Transportes. de's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And we also thought its net debt to EBITDA was a positive. All these things considered, it appears that GMéxico Transportes. de can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with GMéxico Transportes. de .

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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