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.' 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, Melon S.A. (SNSE:MELON) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
Check out our latest analysis for Melon
What Is Melon's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Melon had CL$105.1b of debt, an increase on CL$54.9b, over one year. On the flip side, it has CL$41.7b in cash leading to net debt of about CL$63.5b.
How Strong Is Melon's Balance Sheet?
We can see from the most recent balance sheet that Melon had liabilities of CL$64.6b falling due within a year, and liabilities of CL$119.0b due beyond that. On the other hand, it had cash of CL$41.7b and CL$39.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$102.6b.
When you consider that this deficiency exceeds the company's CL$100.6b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Melon'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.
In the last year Melon had a loss before interest and tax, and actually shrunk its revenue by 9.4%, to CL$188b. That's not what we would hope to see.
Caveat Emptor
Importantly, Melon had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CL$19b at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CL$1.2b over the last twelve months. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Melon , and understanding them should be part of your investment process.
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.
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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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About SNSE:MELON
Melon
Through its subsidiaries, produces, markets, and supplies cement, ready-mix concrete, and aggregates in Chile.
Slightly overvalued very low.
