Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Arca Continental, SAB de CV (BMV:AC) is in debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
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How much debt Arca Continental. of Carry?
You can click on the chart below for historical numbers, but it only shows Arca Continental. had a debt of 50.2 billion Mexican pesos in March 2022, compared to 55.8 billion Mexican pesos a year earlier. However, he also had 35.0 billion pesos in cash, so his net debt is 15.3 billion pesos.
How healthy is Arca Continental. Balance sheet of?
Zooming in on the latest balance sheet data, we can see that Arca Continental. de had debts of 40.7 billion pesos due within 12 months and debts of 67.1 billion pesos due beyond. In compensation for these obligations, it had cash of 35.0 billion pesos as well as receivables valued at 14.5 billion pesos at less than 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 58.4 billion Mexican pesos.
This deficit is not so serious because Arca Continental. de is worth a whopping 227.1 billion Mexican dollars and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Continental arc. de’s net debt is only 0.43 times its EBITDA. And its EBIT easily covers its interest costs, which is 11.8 times the size. So we’re pretty relaxed about his super-conservative use of debt. As good as Arca Continental. de increased its EBIT by 10% compared to last year, further increasing its ability to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But future revenues, more than anything, will determine Arca Continental. the ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Arca Continental. de recorded free cash flow worth 88% of its EBIT, which is higher than what we usually expect. This positions him well to pay off debt if desired.
Our point of view
The good news is that Arca Continental. ‘s demonstrated ability to convert EBIT to free cash flow thrills us like a fluffy puppy does to a toddler. And the good news doesn’t end there, because its interesting cover also reinforces this impression! Zoom out, Arca Continental. seems to be using the debt fairly sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 1 warning sign for Arca Continental. of of which you should be aware.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.