Is Market Herald (ASX:TMH) A Risky Investment?

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. We note that The Market Herald Limited (ASX:TMH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Market Herald

What Is Market Herald's Debt?

The image below, which you can click on for greater detail, shows that Market Herald had debt of AU$9.89m at the end of December 2020, a reduction from AU$11.9m over a year. However, its balance sheet shows it holds AU$18.1m in cash, so it actually has AU$8.23m net cash.

How Healthy Is Market Herald's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Market Herald had liabilities of AU$11.0m due within 12 months and liabilities of AU$15.3m due beyond that. Offsetting this, it had AU$18.1m in cash and AU$2.38m in receivables that were due within 12 months. So it has liabilities totalling AU$5.77m more than its cash and near-term receivables, combined.

Since publicly traded Market Herald shares are worth a total of AU$94.3m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Market Herald also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Market Herald turned things around in the last 12 months, delivering and EBIT of AU$5.1m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Market Herald's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Market Herald 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 most recent year, Market Herald recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Market Herald has AU$8.23m in net cash. So we are not troubled with Market Herald's debt use. 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. To that end, you should learn about the 4 warning signs we've spotted with Market Herald (including 1 which is concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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