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. 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 can see that Grupo Traxión, S.A.B. de C.V. (BMV:TRAXIONA) does use debt in its business. But is this debt a concern to shareholders?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Grupo Traxión. de Carry?
The image below, which you can click on for greater detail, shows that at September 2019 Grupo Traxión. de had debt of Mex$4.92b, up from Mex$2.21b in one year. However, it also had Mex$579.4m in cash, and so its net debt is Mex$4.34b.
A Look At Grupo Traxión. de’s Liabilities
The latest balance sheet data shows that Grupo Traxión. de had liabilities of Mex$3.16b due within a year, and liabilities of Mex$5.93b falling due after that. Offsetting these obligations, it had cash of Mex$579.4m as well as receivables valued at Mex$3.04b due within 12 months. So it has liabilities totalling Mex$5.47b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of Mex$8.18b, so it does suggest shareholders should keep an eye on Grupo Traxión. de’s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Grupo Traxión. de has a quite reasonable net debt to EBITDA multiple of 2.0, its interest cover seems weak, at 2.0. This does have us wondering if the company pays high interest because it is considered risky. In any case, it’s safe to say the company has meaningful debt. It is well worth noting that Grupo Traxión. de’s EBIT shot up like bamboo after rain, gaining 45% 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 future earnings, more than anything, that will determine Grupo Traxión. 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 it’s worth checking how much of that EBIT is backed by 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.
Grupo Traxión. de’s conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think Grupo Traxión. de’s debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For instance, we’ve identified 1 warning sign for Grupo Traxión. de that you should be aware of.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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