Is Matrix Composites & Engineering (ASX:MCE) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Matrix Composites & Engineering Ltd (ASX:MCE) makes use of debt. But should shareholders be worried about its use of debt?

Our free stock report includes 3 warning signs investors should be aware of before investing in Matrix Composites & Engineering. Read for free now.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Matrix Composites & Engineering's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Matrix Composites & Engineering had AU$7.35m of debt in December 2024, down from AU$9.34m, one year before. However, it does have AU$16.9m in cash offsetting this, leading to net cash of AU$9.59m.

How Healthy Is Matrix Composites & Engineering's Balance Sheet?

We can see from the most recent balance sheet that Matrix Composites & Engineering had liabilities of AU$22.0m falling due within a year, and liabilities of AU$32.1m due beyond that. On the other hand, it had cash of AU$16.9m and AU$20.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$16.5m.

Matrix Composites & Engineering has a market capitalization of AU$49.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Matrix Composites & Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

View our latest analysis for Matrix Composites & Engineering

We also note that Matrix Composites & Engineering improved its EBIT from a last year's loss to a positive AU$8.5m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Matrix Composites & Engineering's ability to maintain a healthy balance sheet going forward. 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. Matrix Composites & Engineering 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 year, Matrix Composites & Engineering saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Matrix Composites & Engineering'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$9.59m. So while Matrix Composites & Engineering does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Matrix Composites & Engineering (at least 2 which are significant) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.