Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu doesn’t care when he says, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital ”. When we think about the risk level of a business, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that Grupo KUO, SAB de CV (BMV: KUOB) has debt on its balance sheet. But the most important question is: what is the risk that this debt creates?
Why is debt risky?
Debt helps a business until it struggles to pay it off, either with new capital or free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially large cap companies. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest analysis for Grupo KUO. of
What is Grupo KUO. debt?
You can click on the graph below for historical figures, but it shows that Grupo KUO. de had Mexican $ 16.5 billion in debt in March 2021, up from Mexican $ 19.0 billion a year earlier. However, because it has a cash reserve of Mex $ 4.47 billion, its net debt is less, at around Mexico $ 12 billion.
A look at Grupo KUO. Responsibilities of
Zooming in on the latest balance sheet data, we can see that Grupo KUO. de had liabilities of M $ 14.1 billion due within 12 months and liabilities of M $ 19.2 billion beyond. On the other hand, he had cash of 4.47 billion Mexican dollars and 3.78 billion Mexican dollars in receivables due within the year. Its liabilities therefore exceed the sum of its cash and its (short-term) receivables by 25.1 billion Mexican dollars.
Given that this deficit is actually greater than the company’s market cap of Mexican $ 21.8 billion, we think shareholders should really watch Grupo KUO. debt levels, such as a parent watching their child ride a bicycle for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Although we don’t care about Grupo KUO. With a net debt to EBITDA ratio of 4.9, we believe its extremely low interest coverage of 1.4 times is a sign of high financial leverage. Shareholders should therefore probably be aware that interest charges seem to have really had an impact on the company lately. Worse yet, Grupo KUO. de has seen its EBIT reservoir by 22% over the past 12 months. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But in the end, the future profitability of the company will decide whether Grupo KUO. de can strengthen its track record over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, while the tax authorities love accounting profits, lenders only accept cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Grupo KUO. de recorded substantial negative free cash flow in aggregate. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank both Grupo KUO. Converting EBIT to free cash flow and its history of (not) growing its EBIT make us quite uncomfortable with its debt levels. In addition, its net debt to EBITDA also fails to generate confidence. Taking into account all the factors mentioned above, we believe that Grupo KUO. really carries too much debt. For us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 2 warning signs for Grupo KUO. of that you need to be aware of.
If, after all of this, you’re more interested in a fast-growing company with a rock-solid balance sheet, then take a quick look at our list of cash-growing stocks.
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