Mainfreight (NZSE:MFT) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Mainfreight Limited (NZSE:MFT) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Mainfreight

How Much Debt Does Mainfreight Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Mainfreight had debt of NZ$256.7m, up from NZ$205.9m in one year. But on the other hand it also has NZ$260.9m in cash, leading to a NZ$4.18m net cash position.

How Healthy Is Mainfreight's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mainfreight had liabilities of NZ$937.2m due within 12 months and liabilities of NZ$876.2m due beyond that. Offsetting this, it had NZ$260.9m in cash and NZ$846.6m in receivables that were due within 12 months. So its liabilities total NZ$706.0m more than the combination of its cash and short-term receivables.

Given Mainfreight has a market capitalization of NZ$7.15b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Mainfreight boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Mainfreight has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Mainfreight may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Mainfreight produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Mainfreight's liabilities, but we can be reassured by the fact it has has net cash of NZ$4.18m. And we liked the look of last year's 74% year-on-year EBIT growth. So we don't think Mainfreight's use of debt is risky. 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. We've identified 1 warning sign with Mainfreight , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.