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

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.' 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. As with many other companies Coca-Cola FEMSA, S.A.B. de C.V. (NYSE:KOF) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Coca-Cola FEMSA. de

How Much Debt Does Coca-Cola FEMSA. de Carry?

The image below, which you can click on for greater detail, shows that Coca-Cola FEMSA. de had debt of Mex$65.2b at the end of December 2023, a reduction from Mex$81.8b over a year. However, because it has a cash reserve of Mex$31.1b, its net debt is less, at about Mex$34.2b.

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

According to the last reported balance sheet, Coca-Cola FEMSA. de had liabilities of Mex$54.9b due within 12 months, and liabilities of Mex$84.9b due beyond 12 months. Offsetting this, it had Mex$31.1b in cash and Mex$17.8b in receivables that were due within 12 months. So its liabilities total Mex$91.0b 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$340.8b, 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.

With net debt sitting at just 0.78 times EBITDA, Coca-Cola FEMSA. de is arguably pretty conservatively geared. And it boasts interest cover of 8.7 times, which is more than adequate. Also good is that Coca-Cola FEMSA. de grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Coca-Cola FEMSA. de recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Coca-Cola FEMSA. de's conversion of EBIT to free cash flow 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 net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Coca-Cola FEMSA. de's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Coca-Cola FEMSA. de's dividend history, without delay!

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.