Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Grupo Traxión, S.A.B. de C.V. (BMV:TRAXIONA) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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.
View our latest analysis for Grupo Traxión. de
What Is Grupo Traxión. de's Debt?
As you can see below, at the end of March 2023, Grupo Traxión. de had Mex$9.98b of debt, up from Mex$6.78b a year ago. Click the image for more detail. However, it does have Mex$876.8m in cash offsetting this, leading to net debt of about Mex$9.11b.
How Strong Is Grupo Traxión. de's Balance Sheet?
The latest balance sheet data shows that Grupo Traxión. de had liabilities of Mex$6.29b due within a year, and liabilities of Mex$11.0b falling due after that. On the other hand, it had cash of Mex$876.8m and Mex$5.07b worth of receivables due within a year. So its liabilities total Mex$11.3b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of Mex$16.0b, so it does suggest shareholders should keep an eye on Grupo Traxión. de's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).
While we wouldn't worry about Grupo Traxión. de's net debt to EBITDA ratio of 3.0, we think its super-low interest cover of 1.6 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Another concern for investors might be that Grupo Traxión. de's EBIT fell 11% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Grupo Traxión. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Grupo Traxión. de recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
We'd go so far as to say Grupo Traxión. de's interest cover was disappointing. But at least its conversion of EBIT to free cash flow is not so bad. Looking at the bigger picture, it seems clear to us that Grupo Traxión. de's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Case in point: We've spotted 2 warning signs for Grupo Traxión. de you should be aware of, and 1 of them is a bit concerning.
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.
About BMV:TRAXION A
Grupo Traxión. de
Operates as a mobility and logistics company in Mexico.
Solid track record and good value.
