Is Major Drilling Group International (TSE:MDI) Using Too Much Debt?

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 Major Drilling Group International Inc. (TSE:MDI) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. 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. 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 Major Drilling Group International

What Is Major Drilling Group International's Net Debt?

As you can see below, at the end of January 2022, Major Drilling Group International had CA$50.0m of debt, up from CA$15.7m a year ago. Click the image for more detail. However, it does have CA$78.3m in cash offsetting this, leading to net cash of CA$28.3m.

A Look At Major Drilling Group International's Liabilities

According to the last reported balance sheet, Major Drilling Group International had liabilities of CA$89.0m due within 12 months, and liabilities of CA$79.0m due beyond 12 months. Offsetting these obligations, it had cash of CA$78.3m as well as receivables valued at CA$88.2m due within 12 months. So these liquid assets roughly match the 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$1.04b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Major Drilling Group International also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Major Drilling Group International grew its EBIT by 361% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Major Drilling Group International'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. Major Drilling Group International 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, Major Drilling Group International recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Major Drilling Group International has CA$28.3m in net cash. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CA$48m. So is Major Drilling Group International's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Major Drilling Group International that you should be aware of.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.