Is Micro Focus International (LON:MCRO) Using Too Much Debt?

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.' 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, Micro Focus International plc (LON:MCRO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Micro Focus International

What Is Micro Focus International's Net Debt?

The image below, which you can click on for greater detail, shows that Micro Focus International had debt of US$30.7m at the end of April 2022, a reduction from US$4.65b over a year. But on the other hand it also has US$578.7m in cash, leading to a US$548.0m net cash position.

A Look At Micro Focus International's Liabilities

The latest balance sheet data shows that Micro Focus International had liabilities of US$1.52b due within a year, and liabilities of US$5.01b falling due after that. Offsetting these obligations, it had cash of US$578.7m as well as receivables valued at US$680.4m due within 12 months. So it has liabilities totalling US$5.27b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$1.21b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Micro Focus International would likely require a major re-capitalisation if it had to pay its creditors today. Given that Micro Focus International has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. 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 Micro Focus International can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Micro Focus International had a loss before interest and tax, and actually shrunk its revenue by 7.7%, to US$2.7b. We would much prefer see growth.

So How Risky Is Micro Focus International?

Although Micro Focus International had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$179m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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. For example Micro Focus International has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.