Stock Analysis

Here's Why MEP Infrastructure Developers (NSE:MEP) Has A Meaningful Debt Burden

NSEI:MEP
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies MEP Infrastructure Developers Limited (NSE:MEP) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for MEP Infrastructure Developers

What Is MEP Infrastructure Developers's Debt?

You can click the graphic below for the historical numbers, but it shows that MEP Infrastructure Developers had ₹18.3b of debt in March 2020, down from ₹27.7b, one year before. However, because it has a cash reserve of ₹7.70b, its net debt is less, at about ₹10.6b.

debt-equity-history-analysis
NSEI:MEP Debt to Equity History August 4th 2020

How Strong Is MEP Infrastructure Developers's Balance Sheet?

We can see from the most recent balance sheet that MEP Infrastructure Developers had liabilities of ₹29.5b falling due within a year, and liabilities of ₹17.6b due beyond that. Offsetting this, it had ₹7.70b in cash and ₹5.03b in receivables that were due within 12 months. So it has liabilities totalling ₹34.3b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹3.07b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, MEP Infrastructure Developers would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though MEP Infrastructure Developers's debt is only 2.1, its interest cover is really very low at 0.25. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Shareholders should be aware that MEP Infrastructure Developers's EBIT was down 80% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since MEP Infrastructure Developers will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, MEP Infrastructure Developers actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both MEP Infrastructure Developers's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. It's also worth noting that MEP Infrastructure Developers is in the Infrastructure industry, which is often considered to be quite defensive. We're quite clear that we consider MEP Infrastructure Developers to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for MEP Infrastructure Developers (1 makes us a bit uncomfortable) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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