Does Magontec (ASX:MGL) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Magontec Limited (ASX:MGL) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Magontec

What Is Magontec's Net Debt?

As you can see below, Magontec had AU$14.5m of debt at June 2020, down from AU$20.1m a year prior. However, it does have AU$2.34m in cash offsetting this, leading to net debt of about AU$12.2m.

A Look At Magontec's Liabilities

According to the last reported balance sheet, Magontec had liabilities of AU$29.1m due within 12 months, and liabilities of AU$14.4m due beyond 12 months. On the other hand, it had cash of AU$2.34m and AU$18.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$23.1m.

When you consider that this deficiency exceeds the company's AU$20.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Magontec will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Magontec made a loss at the EBIT level, and saw its revenue drop to AU$109m, which is a fall of 18%. That's not what we would hope to see.

Caveat Emptor

Not only did Magontec's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping AU$2.3m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of AU$2.2m over the last twelve months. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Magontec (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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