Here's Why Major Drilling Group International (TSE:MDI) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Major Drilling Group International Inc. (TSE:MDI) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Major Drilling Group International

What Is Major Drilling Group International's Debt?

The image below, which you can click on for greater detail, shows that at July 2020 Major Drilling Group International had debt of CA$31.1m, up from CA$17.1m in one year. However, because it has a cash reserve of CA$29.1m, its net debt is less, at about CA$2.04m.

How Healthy Is Major Drilling Group International's Balance Sheet?

The latest balance sheet data shows that Major Drilling Group International had liabilities of CA$60.5m due within a year, and liabilities of CA$48.4m falling due after that. On the other hand, it had cash of CA$29.1m and CA$88.4m worth of receivables due within a year. So it can boast CA$8.59m more liquid assets than total liabilities.

Having regard to Major Drilling Group International's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CA$486.3m company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Major Drilling Group International has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Major Drilling Group International's net debt to EBITDA ratio is very low, at 0.047, suggesting the debt is only trivial. But EBIT was only 4.2 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. Importantly, Major Drilling Group International's EBIT fell a jaw-dropping 43% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Major Drilling Group International 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. So we always check how much of that EBIT is translated into free cash flow. In the last two years, Major Drilling Group International created free cash flow amounting to 10.0% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Major Drilling Group International's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its net debt to EBITDA was re-invigorating. We think that Major Drilling Group International's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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