Here's Why McCoy Global (TSE:MCB) Can Manage Its Debt Responsibly

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.' 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, McCoy Global Inc. (TSE:MCB) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for McCoy Global

How Much Debt Does McCoy Global Carry?

As you can see below, at the end of September 2020, McCoy Global had CA$9.07m of debt, up from CA$6.68m a year ago. Click the image for more detail. However, because it has a cash reserve of CA$8.77m, its net debt is less, at about CA$309.0k.

A Look At McCoy Global's Liabilities

The latest balance sheet data shows that McCoy Global had liabilities of CA$8.85m due within a year, and liabilities of CA$10.7m falling due after that. Offsetting these obligations, it had cash of CA$8.77m as well as receivables valued at CA$7.42m due within 12 months. So it has liabilities totalling CA$3.37m more than its cash and near-term receivables, combined.

This deficit isn't so bad because McCoy Global is worth CA$15.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

McCoy Global has a very low debt to EBITDA ratio of 0.13 so it is strange to see weak interest coverage, with last year's EBIT being only 0.18 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, McCoy Global's EBIT fell a jaw-dropping 93% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is McCoy Global's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 two years, McCoy Global generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

We weren't impressed with McCoy Global's interest cover, and its EBIT growth rate made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about McCoy Global's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 4 warning signs we've spotted with McCoy Global .

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. 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.
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