Here's Why Medcomtech (BME:MED) Can Afford Some Debt

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.' 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 Medcomtech, S.A. (BME:MED) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Medcomtech

What Is Medcomtech's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Medcomtech had debt of €11.2m, up from €9.29m in one year. However, because it has a cash reserve of €1.87m, its net debt is less, at about €9.34m.

A Look At Medcomtech's Liabilities

Zooming in on the latest balance sheet data, we can see that Medcomtech had liabilities of €11.3m due within 12 months and liabilities of €9.21m due beyond that. On the other hand, it had cash of €1.87m and €9.20m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €9.45m.

This is a mountain of leverage relative to its market capitalization of €15.6m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Medcomtech 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.

Over 12 months, Medcomtech made a loss at the EBIT level, and saw its revenue drop to €19m, which is a fall of 17%. We would much prefer see growth.

Caveat Emptor

While Medcomtech's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost €109k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through €2.4m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Medcomtech , 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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