Is Megaport (ASX:MP1) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Megaport Limited (ASX:MP1) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Megaport

What Is Megaport's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Megaport had AU$14.9m of debt, an increase on AU$13.7m, over one year. But on the other hand it also has AU$48.7m in cash, leading to a AU$33.9m net cash position.

How Strong Is Megaport's Balance Sheet?

According to the last reported balance sheet, Megaport had liabilities of AU$51.5m due within 12 months, and liabilities of AU$22.8m due beyond 12 months. On the other hand, it had cash of AU$48.7m and AU$26.2m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

Having regard to Megaport's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$1.88b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Megaport boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Megaport's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Megaport wasn't profitable at an EBIT level, but managed to grow its revenue by 40%, to AU$153m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Megaport?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Megaport had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$23m and booked a AU$9.8m accounting loss. But at least it has AU$33.9m on the balance sheet to spend on growth, near-term. Megaport's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Megaport that 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.