These 4 Measures Indicate That Major Drilling Group International (TSE:MDI) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that Major Drilling Group International Inc. (TSE:MDI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Our analysis indicates that MDI is potentially undervalued!

What Is Major Drilling Group International's Debt?

You can click the graphic below for the historical numbers, but it shows that Major Drilling Group International had CA$29.7m of debt in July 2022, down from CA$50.2m, one year before. However, it does have CA$61.1m in cash offsetting this, leading to net cash of CA$31.5m.

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

The latest balance sheet data shows that Major Drilling Group International had liabilities of CA$111.6m due within a year, and liabilities of CA$59.0m falling due after that. On the other hand, it had cash of CA$61.1m and CA$144.8m worth of receivables due within a year. So it actually has CA$35.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Major Drilling Group International could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Major Drilling Group International boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Major Drilling Group International grew its EBIT by 263% 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. While Major Drilling Group International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Major Drilling Group International recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Major Drilling Group International has net cash of CA$31.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 263% year-on-year EBIT growth. So is Major Drilling Group International's debt a risk? It doesn't seem so to us. 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. For example - Major Drilling Group International has 1 warning sign we think you should be aware of.

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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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.