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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Monadelphous Group Limited (ASX:MND) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Monadelphous Group
What Is Monadelphous Group’s Net Debt?
The image below, which you can click on for greater detail, shows that at December 2019 Monadelphous Group had debt of AU$4.41m, up from none in one year. However, it does have AU$163.3m in cash offsetting this, leading to net cash of AU$158.9m.
How Strong Is Monadelphous Group’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Monadelphous Group had liabilities of AU$257.3m due within 12 months and liabilities of AU$77.4m due beyond that. Offsetting this, it had AU$163.3m in cash and AU$359.9m in receivables that were due within 12 months. So it actually has AU$188.5m more liquid assets than total liabilities.
It’s good to see that Monadelphous Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Monadelphous Group has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Monadelphous Group has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Monadelphous Group 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 company can only pay off debt with cold hard cash, not accounting profits. While Monadelphous Group has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Monadelphous Group recorded free cash flow of 32% of its EBIT, which is weaker than we’d expect. That’s not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Monadelphous Group has net cash of AU$158.9m, as well as more liquid assets than liabilities. So we are not troubled with Monadelphous Group’s debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Monadelphous Group is showing 1 warning sign in our investment analysis , you should know about…
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.