Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Matrix Composites & Engineering Ltd (ASX:MCE) 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Matrix Composites & Engineering’s Net Debt?
As you can see below, at the end of June 2019, Matrix Composites & Engineering had AU$7.26m of debt, up from AU$3.8 a year ago. Click the image for more detail. However, it does have AU$9.37m in cash offsetting this, leading to net cash of AU$2.11m.
A Look At Matrix Composites & Engineering’s Liabilities
We can see from the most recent balance sheet that Matrix Composites & Engineering had liabilities of AU$14.5m falling due within a year, and liabilities of AU$723.3k due beyond that. Offsetting these obligations, it had cash of AU$9.37m as well as receivables valued at AU$8.27m due within 12 months. So it can boast AU$2.47m more liquid assets than total liabilities.
This surplus suggests that Matrix Composites & Engineering has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Matrix Composites & Engineering boasts net cash, so it’s fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 4 warning signs for Matrix Composites & Engineering (of which 1 is major) which any shareholder or potential investor should be aware of.
Over 12 months, Matrix Composites & Engineering reported revenue of AU$38m, which is a gain of 95%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Matrix Composites & Engineering?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Matrix Composites & Engineering had negative earnings before interest and tax (EBIT), over the last year. Indeed, in that time it burnt through AU$7.4m of cash and made a loss of AU$8.7m. But at least it has AU$2.11m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Matrix Composites & Engineering may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. For riskier companies like Matrix Composites & Engineering I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.