Is Mitie Group (LON:MTO) A Risky Investment?

Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Mitie Group plc (LON:MTO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Mitie Group

How Much Debt Does Mitie Group Carry?

The image below, which you can click on for greater detail, shows that Mitie Group had debt of UK£226.9m at the end of March 2020, a reduction from UK£264.0m over a year. However, it does have UK£124.6m in cash offsetting this, leading to net debt of about UK£102.3m.

LSE:MTO Historical Debt June 29th 2020
LSE:MTO Historical Debt June 29th 2020

How Strong Is Mitie Group’s Balance Sheet?

We can see from the most recent balance sheet that Mitie Group had liabilities of UK£588.6m falling due within a year, and liabilities of UK£373.7m due beyond that. Offsetting these obligations, it had cash of UK£124.6m as well as receivables valued at UK£375.8m due within 12 months. So its liabilities total UK£461.9m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the UK£300.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, Mitie Group would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.1 and interest cover of 5.2 times, it seems to us that Mitie Group is probably using debt in a pretty reasonable way. So we’d recommend keeping a close eye on the impact financing costs are having on the business. Sadly, Mitie Group’s EBIT actually dropped 2.7% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Mitie Group 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Mitie Group created free cash flow amounting to 4.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We’d go so far as to say Mitie Group’s level of total liabilities was disappointing. But at least it’s pretty decent at managing its debt, based on its EBITDA,; that’s encouraging. Overall, it seems to us that Mitie Group’s balance sheet is really quite a risk to the business. 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. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Take risks, for example – Mitie Group has 4 warning signs (and 1 which is concerning) we think you should know about.

Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.

Promoted
If you’re looking to trade Mitie Group, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.


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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020


Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.