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.' 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. Importantly, MAHLE Metal Leve S.A. (BVMF:LEVE3) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
View our latest analysis for MAHLE Metal Leve
What Is MAHLE Metal Leve's Net Debt?
You can click the graphic below for the historical numbers, but it shows that MAHLE Metal Leve had R$240.8m of debt in March 2021, down from R$742.3m, one year before. But on the other hand it also has R$335.5m in cash, leading to a R$94.7m net cash position.
How Strong Is MAHLE Metal Leve's Balance Sheet?
According to the last reported balance sheet, MAHLE Metal Leve had liabilities of R$852.6m due within 12 months, and liabilities of R$420.5m due beyond 12 months. Offsetting this, it had R$335.5m in cash and R$678.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$259.2m.
Of course, MAHLE Metal Leve has a market capitalization of R$4.27b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, MAHLE Metal Leve also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, MAHLE Metal Leve grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MAHLE Metal Leve'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. MAHLE Metal Leve 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 three years, MAHLE Metal Leve recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing up
We could understand if investors are concerned about MAHLE Metal Leve's liabilities, but we can be reassured by the fact it has has net cash of R$94.7m. And it impressed us with free cash flow of R$437m, being 82% of its EBIT. So is MAHLE Metal Leve's debt a risk? It doesn't seem so to us. 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 - MAHLE Metal Leve has 3 warning signs we think 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.
If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
About BOVESPA:LEVE3
MAHLE Metal Leve
An automotive parts company, manufactures and sells components for internal combustion engines and automotive filters in South America, Europe, Central and North America, Africa, Asia, Oceania, and the Middle East.
Undervalued with adequate balance sheet and pays a dividend.
