Here's Why Coca-Cola FEMSA. de (NYSE:KOF) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Coca-Cola FEMSA, S.A.B. de C.V. (NYSE:KOF) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Coca-Cola FEMSA. de

What Is Coca-Cola FEMSA. de's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Coca-Cola FEMSA. de had Mex$70.3b of debt in September 2023, down from Mex$77.5b, one year before. On the flip side, it has Mex$38.5b in cash leading to net debt of about Mex$31.7b.

How Healthy Is Coca-Cola FEMSA. de's Balance Sheet?

We can see from the most recent balance sheet that Coca-Cola FEMSA. de had liabilities of Mex$58.9b falling due within a year, and liabilities of Mex$84.8b due beyond that. On the other hand, it had cash of Mex$38.5b and Mex$18.4b worth of receivables due within a year. So its liabilities total Mex$86.8b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Coca-Cola FEMSA. de has a huge market capitalization of Mex$299.2b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Coca-Cola FEMSA. de has a low net debt to EBITDA ratio of only 0.78. And its EBIT easily covers its interest expense, being 16.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Coca-Cola FEMSA. de has increased its EBIT by 8.7% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Coca-Cola FEMSA. de can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, Coca-Cola FEMSA. de produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Coca-Cola FEMSA. de's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Taking all this data into account, it seems to us that Coca-Cola FEMSA. de takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Given Coca-Cola FEMSA. de has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.