Is Macquarie Telecom Group (ASX:MAQ) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 can see that Macquarie Telecom Group Limited (ASX:MAQ) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Macquarie Telecom Group

What Is Macquarie Telecom Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Macquarie Telecom Group had AU$126.0m of debt in June 2022, down from AU$132.0m, one year before. On the flip side, it has AU$2.95m in cash leading to net debt of about AU$123.0m.

How Healthy Is Macquarie Telecom Group's Balance Sheet?

According to the last reported balance sheet, Macquarie Telecom Group had liabilities of AU$61.6m due within 12 months, and liabilities of AU$265.3m due beyond 12 months. Offsetting these obligations, it had cash of AU$2.95m as well as receivables valued at AU$38.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$285.4m.

While this might seem like a lot, it is not so bad since Macquarie Telecom Group has a market capitalization of AU$1.28b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Macquarie Telecom Group has net debt worth 2.0 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.6 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Macquarie Telecom Group grew its EBIT by 3.7% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Macquarie Telecom Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Macquarie Telecom Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Macquarie Telecom Group's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Macquarie Telecom Group stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Macquarie Telecom Group (1 is a bit concerning!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.