Is Monadelphous Group (ASX:MND) Using Too Much Debt?

Warren Buffett famously said, '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 can see that Monadelphous Group Limited (ASX:MND) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Monadelphous Group

What Is Monadelphous Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Monadelphous Group had AU$14.1m of debt, an increase on AU$6.14m, over one year. However, its balance sheet shows it holds AU$189.9m in cash, so it actually has AU$175.8m net cash.

A Look At Monadelphous Group's Liabilities

We can see from the most recent balance sheet that Monadelphous Group had liabilities of AU$234.3m falling due within a year, and liabilities of AU$81.7m due beyond that. On the other hand, it had cash of AU$189.9m and AU$339.1m worth of receivables due within a year. So it actually has AU$213.0m more liquid assets than total liabilities.

This surplus suggests that Monadelphous Group is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Monadelphous Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Monadelphous Group's load is not too heavy, because its EBIT was down 20% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Monadelphous Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Monadelphous Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Monadelphous Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Monadelphous Group has net cash of AU$175.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$52m, being 108% of its EBIT. So is Monadelphous Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Monadelphous Group .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.