Is MBH (FRA:M8H) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 MBH Corporation PLC (FRA:M8H) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for MBH

How Much Debt Does MBH Carry?

As you can see below, at the end of December 2021, MBH had UK£38.0m of debt, up from UK£34.6m a year ago. Click the image for more detail. On the flip side, it has UK£6.09m in cash leading to net debt of about UK£31.9m.

A Look At MBH's Liabilities

According to the last reported balance sheet, MBH had liabilities of UK£36.8m due within 12 months, and liabilities of UK£55.6m due beyond 12 months. Offsetting these obligations, it had cash of UK£6.09m as well as receivables valued at UK£18.8m due within 12 months. So it has liabilities totalling UK£67.5m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the UK£12.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, MBH would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

MBH has a rather high debt to EBITDA ratio of 5.3 which suggests a meaningful debt load. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. However, it should be some comfort for shareholders to recall that MBH actually grew its EBIT by a hefty 293%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MBH can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, MBH's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, MBH's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that MBH's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example MBH has 5 warning signs (and 1 which is concerning) we think you should know about.

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. 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.