We Think Megaport (ASX:MP1) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Megaport Limited (ASX:MP1) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Megaport

What Is Megaport's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Megaport had AU$17.4m of debt, an increase on AU$12.1m, over one year. However, its balance sheet shows it holds AU$62.5m in cash, so it actually has AU$45.1m net cash.

How Strong Is Megaport's Balance Sheet?

We can see from the most recent balance sheet that Megaport had liabilities of AU$51.1m falling due within a year, and liabilities of AU$19.3m due beyond that. Offsetting these obligations, it had cash of AU$62.5m as well as receivables valued at AU$30.1m due within 12 months. So it can boast AU$22.2m more liquid assets than 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$2.15b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Megaport has more cash than debt is arguably a good indication that it can manage its debt safely.

We also note that Megaport improved its EBIT from a last year's loss to a positive AU$3.9m. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Megaport 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 last year, Megaport actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Megaport has net cash of AU$45.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$9.3m, being 240% of its EBIT. So we don't think Megaport's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Megaport you should be aware of.

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.