Betterware de MéxicoP.I. de (NASDAQ:BWMX) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Betterware de México, S.A.P.I. de C.V. (NASDAQ:BWMX) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Betterware de MéxicoP.I. de

What Is Betterware de MéxicoP.I. de's Debt?

The image below, which you can click on for greater detail, shows that Betterware de MéxicoP.I. de had debt of Mex$5.31b at the end of September 2023, a reduction from Mex$6.62b over a year. However, it does have Mex$496.1m in cash offsetting this, leading to net debt of about Mex$4.82b.

A Look At Betterware de MéxicoP.I. de's Liabilities

Zooming in on the latest balance sheet data, we can see that Betterware de MéxicoP.I. de had liabilities of Mex$4.07b due within 12 months and liabilities of Mex$5.97b due beyond that. Offsetting this, it had Mex$496.1m in cash and Mex$1.39b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Mex$8.16b.

This deficit is considerable relative to its market capitalization of Mex$8.75b, so it does suggest shareholders should keep an eye on Betterware de MéxicoP.I. de's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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.

Betterware de MéxicoP.I. de has net debt worth 2.0 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.7 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. If Betterware de MéxicoP.I. de can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Betterware de MéxicoP.I. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Betterware de MéxicoP.I. de recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Betterware de MéxicoP.I. de's interest cover and its level of total liabilities were discouraging. At least its EBIT growth rate gives us reason to be optimistic. Taking the abovementioned factors together we do think Betterware de MéxicoP.I. de's debt poses some risks to the business. 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. To that end, you should learn about the 3 warning signs we've spotted with Betterware de MéxicoP.I. de (including 1 which is concerning) .

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.

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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.