Stock Analysis

MNF Group (ASX:MNF) Seems To Use Debt Quite Sensibly

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ASX:SYM
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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that MNF Group Limited (ASX:MNF) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for MNF Group

What Is MNF Group's Debt?

As you can see below, MNF Group had AU$30.7m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds AU$52.2m in cash, so it actually has AU$21.6m net cash.

debt-equity-history-analysis
ASX:MNF Debt to Equity History June 10th 2021

A Look At MNF Group's Liabilities

According to the last reported balance sheet, MNF Group had liabilities of AU$37.5m due within 12 months, and liabilities of AU$53.7m due beyond 12 months. On the other hand, it had cash of AU$52.2m and AU$37.7m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to MNF Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$474.2m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, MNF Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that MNF Group has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if MNF Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. MNF Group 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. Looking at the most recent three years, MNF Group recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about MNF Group's liabilities, but we can be reassured by the fact it has has net cash of AU$21.6m. And we liked the look of last year's 27% year-on-year EBIT growth. So we don't think MNF Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with MNF Group , and understanding them should be part of your investment process.

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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