Is Mayr-Melnhof Karton (VIE:MMK) A Risky Investment?

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. We note that Mayr-Melnhof Karton AG (VIE:MMK) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Mayr-Melnhof Karton

How Much Debt Does Mayr-Melnhof Karton Carry?

You can click the graphic below for the historical numbers, but it shows that Mayr-Melnhof Karton had €230.9m of debt in September 2020, down from €432.1m, one year before. However, because it has a cash reserve of €119.1m, its net debt is less, at about €111.9m.

How Strong Is Mayr-Melnhof Karton's Balance Sheet?

According to the last reported balance sheet, Mayr-Melnhof Karton had liabilities of €477.1m due within 12 months, and liabilities of €408.3m due beyond 12 months. Offsetting these obligations, it had cash of €119.1m as well as receivables valued at €453.0m due within 12 months. So its liabilities total €313.3m more than the combination of its cash and short-term receivables.

Of course, Mayr-Melnhof Karton has a market capitalization of €3.39b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Mayr-Melnhof Karton's net debt is only 0.28 times its EBITDA. And its EBIT covers its interest expense a whopping 50.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Mayr-Melnhof Karton saw its EBIT drop by 2.5% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Mayr-Melnhof Karton 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Mayr-Melnhof Karton recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Mayr-Melnhof Karton's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. When we consider the range of factors above, it looks like Mayr-Melnhof Karton is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Mayr-Melnhof Karton has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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