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’. 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. We note that MPC Container Ships ASA (OB:MPCC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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.
What Is MPC Container Ships’s Net Debt?
As you can see below, at the end of September 2019, MPC Container Ships had US$273.0m of debt, up from US$248 a year ago. Click the image for more detail. However, because it has a cash reserve of US$30.2m, its net debt is less, at about US$242.8m.
A Look At MPC Container Ships’s Liabilities
According to the last reported balance sheet, MPC Container Ships had liabilities of US$20.0m due within 12 months, and liabilities of US$270.5m due beyond 12 months. Offsetting these obligations, it had cash of US$30.2m as well as receivables valued at US$24.1m due within 12 months. So its liabilities total US$236.2m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company’s US$191.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MPC Container Ships 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.
In the last year MPC Container Ships wasn’t profitable at an EBIT level, but managed to grow its revenue by 34%, to US$193m. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, MPC Container Ships still had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost US$11m at the EBIT level. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$34m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. For example, we’ve discovered 3 warning signs for MPC Container Ships which any shareholder or potential investor 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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