Mountview Estates (LON:MTVW) Seems To Use Debt Quite Sensibly

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. We can see that Mountview Estates P.L.C. (LON:MTVW) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Mountview Estates

How Much Debt Does Mountview Estates Carry?

The image below, which you can click on for greater detail, shows that Mountview Estates had debt of UK£21.9m at the end of March 2021, a reduction from UK£33.2m over a year. On the flip side, it has UK£597.0k in cash leading to net debt of about UK£21.3m.

How Healthy Is Mountview Estates' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mountview Estates had liabilities of UK£7.54m due within 12 months and liabilities of UK£25.0m due beyond that. Offsetting this, it had UK£597.0k in cash and UK£111.0k in receivables that were due within 12 months. So it has liabilities totalling UK£31.8m more than its cash and near-term receivables, combined.

Of course, Mountview Estates has a market capitalization of UK£540.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Mountview Estates has a low net debt to EBITDA ratio of only 0.57. And its EBIT easily covers its interest expense, being 55.3 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Mountview Estates grew its EBIT by 4.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Mountview Estates'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Mountview Estates produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Mountview Estates's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Zooming out, Mountview Estates seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Mountview Estates that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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