Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk’. 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. As with many other companies Mycronic AB (publ) (STO:MYCR) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Mycronic Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Mycronic had kr210.7m of debt, an increase on kr0.9, over one year. But on the other hand it also has kr826.2m in cash, leading to a kr615.5m net cash position.
A Look At Mycronic’s Liabilities
The latest balance sheet data shows that Mycronic had liabilities of kr1.55b due within a year, and liabilities of kr354.1m falling due after that. Offsetting these obligations, it had cash of kr826.2m as well as receivables valued at kr1.01b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr65.5m.
Having regard to Mycronic’s size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the kr19.0b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Despite its noteworthy liabilities, Mycronic boasts net cash, so it’s fair to say it does not have a heavy debt load!
On the other hand, Mycronic’s EBIT dived 15%, over the last year. 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 Mycronic can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Mycronic 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. During the last three years, Mycronic produced sturdy free cash flow equating to 60% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about Mycronic’s liabilities, but we can be reassured by the fact it has has net cash of kr615.5m. So we don’t have any problem with Mycronic’s use of debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we’ve spotted with Mycronic (including 1 which is is a bit unpleasant) .
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.
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