The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies MMA Offshore Limited (ASX:MRM) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.
How Much Debt Does MMA Offshore Carry?
The image below, which you can click on for greater detail, shows that MMA Offshore had debt of AU$165.5m at the end of December 2020, a reduction from AU$271.2m over a year. However, because it has a cash reserve of AU$92.9m, its net debt is less, at about AU$72.6m.
How Strong Is MMA Offshore's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that MMA Offshore had liabilities of AU$70.6m due within 12 months and liabilities of AU$164.7m due beyond that. On the other hand, it had cash of AU$92.9m and AU$52.0m worth of receivables due within a year. So it has liabilities totalling AU$90.4m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of AU$109.6m, so it does suggest shareholders should keep an eye on MMA Offshore's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MMA Offshore 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.
Over 12 months, MMA Offshore reported revenue of AU$262m, which is a gain of 4.4%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months MMA Offshore produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable AU$19m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of AU$69m. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for MMA Offshore (of which 1 is potentially serious!) you should know about.
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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