Is Monnari Trade (WSE:MON) Using Too Much Debt?

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. As with many other companies Monnari Trade S.A. (WSE:MON) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Monnari Trade

What Is Monnari Trade's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Monnari Trade had debt of zł17.7m, up from zł12.0m in one year. However, its balance sheet shows it holds zł18.3m in cash, so it actually has zł596.0k net cash.

How Strong Is Monnari Trade's Balance Sheet?

According to the last reported balance sheet, Monnari Trade had liabilities of zł82.4m due within 12 months, and liabilities of zł41.4m due beyond 12 months. Offsetting these obligations, it had cash of zł18.3m as well as receivables valued at zł41.5m due within 12 months. So it has liabilities totalling zł63.9m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of zł70.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Monnari Trade boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Monnari Trade made a loss at the EBIT level, last year, it was also good to see that it generated zł17m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Monnari Trade will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Monnari Trade 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. Happily for any shareholders, Monnari Trade actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although Monnari Trade's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of zł596.0k. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in zł18m. So we are not troubled with Monnari Trade's debt use. 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. For example, we've discovered 2 warning signs for Monnari Trade (1 doesn't sit too well with us!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.