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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that MNF Group Limited (ASX:MNF) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
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. But it also has AU$52.2m in cash to offset that, meaning it has AU$21.6m net cash.
How Strong Is MNF Group's Balance Sheet?
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. Offsetting these obligations, it had cash of AU$52.2m as well as receivables valued at AU$37.7m due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that MNF Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$425.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, MNF Group boasts net cash, so it's fair to say it does not have a heavy debt load!
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. 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 MNF Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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's not great, when it comes to paying down debt.
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 it impressed us with its EBIT growth of 27% over the last year. So we don't think MNF Group's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that MNF Group insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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