Is Mainfreight (NZSE:MFT) A Risky Investment?

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. Importantly, Mainfreight Limited (NZSE:MFT) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Mainfreight

What Is Mainfreight's Net Debt?

As you can see below, Mainfreight had NZ$181.0m of debt at September 2023, down from NZ$256.7m a year prior. But on the other hand it also has NZ$234.5m in cash, leading to a NZ$53.5m net cash position.

A Look At Mainfreight's Liabilities

We can see from the most recent balance sheet that Mainfreight had liabilities of NZ$798.7m falling due within a year, and liabilities of NZ$907.8m due beyond that. Offsetting these obligations, it had cash of NZ$234.5m as well as receivables valued at NZ$647.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NZ$824.0m.

Since publicly traded Mainfreight shares are worth a total of NZ$7.12b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Mainfreight also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Mainfreight's load is not too heavy, because its EBIT was down 25% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mainfreight's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Mainfreight has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Mainfreight recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Mainfreight's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NZ$53.5m. So we don't have any problem with Mainfreight's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Mainfreight insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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. 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.