Grupo Traxión. de (BMV:TRAXIONA) Has A Somewhat Strained Balance Sheet

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.' 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. We note that Grupo Traxión, S.A.B. de C.V. (BMV:TRAXIONA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Grupo Traxión. de

How Much Debt Does Grupo Traxión. de Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Grupo Traxión. de had debt of Mex$5.86b, up from Mex$4.92b in one year. However, it also had Mex$1.60b in cash, and so its net debt is Mex$4.26b.

How Strong Is Grupo Traxión. de's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Grupo Traxión. de had liabilities of Mex$3.64b due within 12 months and liabilities of Mex$6.59b due beyond that. Offsetting this, it had Mex$1.60b in cash and Mex$3.79b in receivables that were due within 12 months. So its liabilities total Mex$4.84b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Grupo Traxión. de has a market capitalization of Mex$12.4b, 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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Grupo Traxión. de's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 2.6 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We note that Grupo Traxión. de grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Grupo Traxión. de's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Grupo Traxión. de saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Grupo Traxión. de's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. When we consider all the factors discussed, it seems to us that Grupo Traxión. de is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Grupo Traxión. de has 2 warning signs (and 1 which is potentially serious) we think you should know about.

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.

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This article by Simply Wall St is general in nature. 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.
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