We Think Mitchell Services (ASX:MSV) Is Taking Some Risk With Its Debt

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 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 Mitchell Services Limited (ASX:MSV) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Mitchell Services

What Is Mitchell Services's Debt?

You can click the graphic below for the historical numbers, but it shows that Mitchell Services had AU$9.80m of debt in December 2021, down from AU$13.4m, one year before. However, its balance sheet shows it holds AU$10.4m in cash, so it actually has AU$591.5k net cash.

How Healthy Is Mitchell Services' Balance Sheet?

We can see from the most recent balance sheet that Mitchell Services had liabilities of AU$44.4m falling due within a year, and liabilities of AU$25.6m due beyond that. Offsetting this, it had AU$10.4m in cash and AU$27.4m in receivables that were due within 12 months. So it has liabilities totalling AU$32.1m more than its cash and near-term receivables, combined.

Mitchell Services has a market capitalization of AU$74.2m, 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, Mitchell Services also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that Mitchell Services improved its EBIT from a last year's loss to a positive AU$1.7m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Mitchell Services 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Mitchell Services has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Mitchell Services 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

While Mitchell Services does have more liabilities than liquid assets, it also has net cash of AU$591.5k. Despite its cash we think that Mitchell Services seems to struggle to convert EBIT to free cash flow, so we are wary of the stock. 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. Case in point: We've spotted 3 warning signs for Mitchell Services you should be aware of.

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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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.