We Think Modiin Energy-Limited Partnership (TLV:MDIN) Is Taking Some Risk With Its 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.' 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. As with many other companies Modiin Energy-Limited Partnership (TLV:MDIN) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Modiin Energy-Limited Partnership's Debt?

The chart below, which you can click on for greater detail, shows that Modiin Energy-Limited Partnership had US$16.1m in debt in June 2022; about the same as the year before. However, it does have US$11.4m in cash offsetting this, leading to net debt of about US$4.73m.

A Look At Modiin Energy-Limited Partnership's Liabilities

Zooming in on the latest balance sheet data, we can see that Modiin Energy-Limited Partnership had liabilities of US$9.50m due within 12 months and liabilities of US$13.5m due beyond that. Offsetting these obligations, it had cash of US$11.4m as well as receivables valued at US$3.49m due within 12 months. So its liabilities total US$8.11m more than the combination of its cash and short-term receivables.

Modiin Energy-Limited Partnership has a market capitalization of US$23.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Looking at its net debt to EBITDA of 0.43 and interest cover of 3.1 times, it seems to us that Modiin Energy-Limited Partnership is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that Modiin Energy-Limited Partnership improved its EBIT from a last year's loss to a positive US$7.1m. 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 Modiin Energy-Limited Partnership 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Modiin Energy-Limited Partnership reported free cash flow worth 20% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Modiin Energy-Limited Partnership's interest cover and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its net debt to EBITDA tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Modiin Energy-Limited Partnership is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Modiin Energy-Limited Partnership , and understanding them should be part of your investment process.

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.