Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, MaxiPARTS Limited (ASX:MXI) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for MaxiPARTS
What Is MaxiPARTS's Debt?
The image below, which you can click on for greater detail, shows that MaxiPARTS had debt of AU$17.3m at the end of June 2021, a reduction from AU$37.5m over a year. But on the other hand it also has AU$22.4m in cash, leading to a AU$5.19m net cash position.
How Strong Is MaxiPARTS' Balance Sheet?
According to the last reported balance sheet, MaxiPARTS had liabilities of AU$126.9m due within 12 months, and liabilities of AU$31.8m due beyond 12 months. On the other hand, it had cash of AU$22.4m and AU$33.1m worth of receivables due within a year. So it has liabilities totalling AU$103.1m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of AU$125.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, MaxiPARTS boasts net cash, so it's fair to say it does not have a heavy debt load!
Pleasingly, MaxiPARTS is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 103% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine MaxiPARTS's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MaxiPARTS 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. Over the last three years, MaxiPARTS actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
Although MaxiPARTS's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$5.19m. And it impressed us with free cash flow of AU$25m, being 394% of its EBIT. So we are not troubled with MaxiPARTS's debt use. 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. For example - MaxiPARTS has 3 warning signs we think you should be aware of.
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.
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About ASX:MXI
MaxiPARTS
Distributes and sells commercial truck and trailer parts in Australia.
Flawless balance sheet and good value.