These 4 Measures Indicate That MG International (EPA:ALMGI) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, MG International (EPA:ALMGI) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for MG International

What Is MG International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 MG International had €12.6m of debt, an increase on €8.13m, over one year. On the flip side, it has €5.45m in cash leading to net debt of about €7.20m.

A Look At MG International's Liabilities

Zooming in on the latest balance sheet data, we can see that MG International had liabilities of €16.9m due within 12 months and liabilities of €10.3m due beyond that. On the other hand, it had cash of €5.45m and €19.5m worth of receivables due within a year. So its liabilities total €2.22m more than the combination of its cash and short-term receivables.

Since publicly traded MG International shares are worth a total of €22.5m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MG International's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 19.9 times its interest expense, implies the debt load is as light as a peacock feather. In addition to that, we're happy to report that MG International has boosted its EBIT by 71%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is MG International'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, MG International saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Happily, MG International's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that MG International can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - MG International has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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