Here's Why Matas (CPH:MATAS) Can Manage Its Debt Responsibly

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.' 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, Matas A/S (CPH:MATAS) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Matas

What Is Matas's Debt?

The image below, which you can click on for greater detail, shows that Matas had debt of kr.1.10b at the end of March 2021, a reduction from kr.1.82b over a year. On the flip side, it has kr.40.7m in cash leading to net debt of about kr.1.06b.

How Strong Is Matas' Balance Sheet?

The latest balance sheet data shows that Matas had liabilities of kr.2.32b due within a year, and liabilities of kr.781.6m falling due after that. Offsetting this, it had kr.40.7m in cash and kr.39.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.3.02b.

This deficit is considerable relative to its market capitalization of kr.4.37b, so it does suggest shareholders should keep an eye on Matas' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

We'd say that Matas's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its strong interest cover of 14.2 times, makes us even more comfortable. We note that Matas grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Matas 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. Happily for any shareholders, Matas actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Matas's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. When we consider the range of factors above, it looks like Matas is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Matas that 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. 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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