Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Magontec Limited (ASX:MGL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Magontec Carry?
You can click the graphic below for the historical numbers, but it shows that Magontec had AU$3.60m of debt in June 2022, down from AU$12.6m, one year before. However, it does have AU$4.76m in cash offsetting this, leading to net cash of AU$1.16m.
How Healthy Is Magontec's Balance Sheet?
The latest balance sheet data shows that Magontec had liabilities of AU$27.8m due within a year, and liabilities of AU$11.3m falling due after that. On the other hand, it had cash of AU$4.76m and AU$23.9m worth of receivables due within a year. So it has liabilities totalling AU$10.4m more than its cash and near-term receivables, combined.
Magontec has a market capitalization of AU$26.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Magontec also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Magontec grew its EBIT by 1,117% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Magontec's earnings that will influence how the balance sheet holds up in the future. 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Magontec 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 most recent two years, Magontec recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although Magontec'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$1.16m. And it impressed us with its EBIT growth of 1,117% over the last year. So we don't think Magontec's use of debt is risky. 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. For example, we've discovered 2 warning signs for Magontec that you should be aware of before investing here.
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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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.
Magontec Limited, together with its subsidiaries, engages in the research, development, manufacture, and sale of generic and specialist alloys in Asia, the Americas, Europe, and internationally.
Flawless balance sheet with outstanding track record.