Does Michelmersh Brick Holdings (LON:MBH) Have A Healthy Balance Sheet?

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.' 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. Importantly, Michelmersh Brick Holdings plc (LON:MBH) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Michelmersh Brick Holdings

How Much Debt Does Michelmersh Brick Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Michelmersh Brick Holdings had UK£11.5m of debt in December 2020, down from UK£21.5m, one year before. But on the other hand it also has UK£12.2m in cash, leading to a UK£770.0k net cash position.

How Healthy Is Michelmersh Brick Holdings' Balance Sheet?

According to the last reported balance sheet, Michelmersh Brick Holdings had liabilities of UK£13.8m due within 12 months, and liabilities of UK£22.4m due beyond 12 months. Offsetting these obligations, it had cash of UK£12.2m as well as receivables valued at UK£9.84m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£14.1m.

Given Michelmersh Brick Holdings has a market capitalization of UK£136.2m, 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, Michelmersh Brick Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Michelmersh Brick Holdings has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Michelmersh Brick Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Michelmersh Brick Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Michelmersh Brick Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Michelmersh Brick Holdings does have more liabilities than liquid assets, it also has net cash of UK£770.0k. The cherry on top was that in converted 119% of that EBIT to free cash flow, bringing in UK£9.1m. So we are not troubled with Michelmersh Brick Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Michelmersh Brick Holdings you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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