Stock Analysis

Is Mader Group (ASX:MAD) Using Too Much Debt?

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ASX:MAD
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Warren Buffett famously said, '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. As with many other companies Mader Group Limited (ASX:MAD) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does Mader Group Carry?

As you can see below, Mader Group had AU$25.6m of debt at December 2020, down from AU$34.9m a year prior. However, it also had AU$5.73m in cash, and so its net debt is AU$19.9m.

debt-equity-history-analysis
ASX:MAD Debt to Equity History March 25th 2021

A Look At Mader Group's Liabilities

We can see from the most recent balance sheet that Mader Group had liabilities of AU$40.3m falling due within a year, and liabilities of AU$13.1m due beyond that. Offsetting these obligations, it had cash of AU$5.73m as well as receivables valued at AU$54.9m due within 12 months. So it can boast AU$7.25m more liquid assets than total liabilities.

This surplus suggests that Mader Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Mader Group has a low net debt to EBITDA ratio of only 0.60. And its EBIT covers its interest expense a whopping 24.4 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Mader Group grew its EBIT by 15% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Mader 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Mader Group reported free cash flow worth 6.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Happily, Mader Group's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Mader Group takes a pretty sensible approach to 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Mader Group 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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