Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that KUO Group, SAB de CV (BMV: KUOB) has debt on its balance sheet. But the most important question is: what risk does this debt create?
Why is debt risky?
Debt helps a business until the business struggles to repay it, either with new capital or with 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 must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, debt can be an important tool in businesses, especially capital intensive businesses. 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, given that it has a cash reserve of Mex 4.47 billion, its net debt is less, at around Mex 12.0 billion.
A look at Grupo KUO. Responsibilities of
Zooming in on the latest balance sheet data, we can see that Grupo KUO. de had a liability of M $ 14.1 billion due within 12 months and a liability 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 one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by Mexican $ 25.1 billion.
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 a 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 amount of debt, as well as the interest rates paid on it.
While we wouldn’t worry about Grupo KUO. Net debt to EBITDA ratio of 4.9, we believe its ultra-low interest coverage of 1.4 times is a sign of high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. 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 this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard 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 a significant negative free cash flow in total. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
To be frank, both Grupo KUO. De’s EBIT conversion to free cash flow and its history of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to inspire 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 think 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 of which you should be aware.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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