Mendelson Infrastructures & Industries (TLV:MNIN) 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 Mendelson Infrastructures & Industries Ltd. (TLV:MNIN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Mendelson Infrastructures & Industries

What Is Mendelson Infrastructures & Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Mendelson Infrastructures & Industries had ₪105.4m of debt in September 2020, down from ₪147.5m, one year before. However, it also had ₪15.5m in cash, and so its net debt is ₪89.9m.

A Look At Mendelson Infrastructures & Industries' Liabilities

The latest balance sheet data shows that Mendelson Infrastructures & Industries had liabilities of ₪320.4m due within a year, and liabilities of ₪141.7m falling due after that. On the other hand, it had cash of ₪15.5m and ₪354.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪92.0m.

While this might seem like a lot, it is not so bad since Mendelson Infrastructures & Industries has a market capitalization of ₪317.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Mendelson Infrastructures & Industries's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 4.9 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Mendelson Infrastructures & Industries grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mendelson Infrastructures & Industries will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last three years, Mendelson Infrastructures & Industries recorded free cash flow worth a fulsome 100% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Mendelson Infrastructures & Industries's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Mendelson Infrastructures & Industries seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Mendelson Infrastructures & Industries has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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