We Think Macfarlane Group (LON:MACF) Can Stay On Top Of Its 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Macfarlane Group PLC (LON:MACF) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Macfarlane Group

How Much Debt Does Macfarlane Group Carry?

As you can see below, Macfarlane Group had UK£5.54m of debt at June 2020, down from UK£18.8m a year prior. However, it does have UK£4.73m in cash offsetting this, leading to net debt of about UK£816.0k.

A Look At Macfarlane Group's Liabilities

According to the last reported balance sheet, Macfarlane Group had liabilities of UK£61.2m due within 12 months, and liabilities of UK£27.1m due beyond 12 months. On the other hand, it had cash of UK£4.73m and UK£44.6m worth of receivables due within a year. So its liabilities total UK£38.9m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Macfarlane Group has a market capitalization of UK£136.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Carrying virtually no net debt, Macfarlane Group has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.048 times EBITDA and EBIT covering interest a whopping 12.3 times, it's clear that Macfarlane Group is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. Macfarlane Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Macfarlane Group'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.

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, Macfarlane Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Macfarlane Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think Macfarlane Group's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. We'd be motivated to research the stock further if we found out that Macfarlane Group insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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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