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.' 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. We can see that Mondi plc (LON:MNDI) does use debt in its business. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Mondi Carry?
The chart below, which you can click on for greater detail, shows that Mondi had €1.99b in debt in December 2020; about the same as the year before. However, because it has a cash reserve of €382.0m, its net debt is less, at about €1.61b.
How Healthy Is Mondi's Balance Sheet?
According to the last reported balance sheet, Mondi had liabilities of €1.39b due within 12 months, and liabilities of €2.60b due beyond 12 months. On the other hand, it had cash of €382.0m and €1.01b worth of receivables due within a year. So its liabilities total €2.60b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Mondi has a huge market capitalization of €10.4b, 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.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Mondi's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 10.3 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Mondi has seen its EBIT plunge 20% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Mondi can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Mondi produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Mondi's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its interest cover was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Mondi is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Case in point: We've spotted 2 warning signs for Mondi you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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Mondi plc engages in the manufacture and sale of packaging and paper products in Africa, Western Europe, Emerging Europe, Russia, North America, South America, Asia, and Australia.
Flawless balance sheet with outstanding track record and pays a dividend.