Is AS Merko Ehitus (TAL:MRK1T) A Risky Investment?

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.' 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, AS Merko Ehitus (TAL:MRK1T) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for AS Merko Ehitus

What Is AS Merko Ehitus's Debt?

You can click the graphic below for the historical numbers, but it shows that AS Merko Ehitus had €26.4m of debt in December 2020, down from €60.8m, one year before. However, it does have €47.5m in cash offsetting this, leading to net cash of €21.1m.

A Look At AS Merko Ehitus' Liabilities

According to the last reported balance sheet, AS Merko Ehitus had liabilities of €77.0m due within 12 months, and liabilities of €22.4m due beyond 12 months. On the other hand, it had cash of €47.5m and €30.1m worth of receivables due within a year. So it has liabilities totalling €21.9m more than its cash and near-term receivables, combined.

Given AS Merko Ehitus has a market capitalization of €223.9m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, AS Merko Ehitus also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, AS Merko Ehitus grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since AS Merko Ehitus will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. AS Merko Ehitus 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, AS Merko Ehitus actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about AS Merko Ehitus's liabilities, but we can be reassured by the fact it has has net cash of €21.1m. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in €58m. So we don't think AS Merko Ehitus's use of debt is risky. 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, we've discovered 2 warning signs for AS Merko Ehitus that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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