Is MEGARON Spólka Akcyjna (WSE:MEG) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, MEGARON Spólka Akcyjna (WSE:MEG) does carry debt. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for MEGARON Spólka Akcyjna

What Is MEGARON Spólka Akcyjna's Debt?

You can click the graphic below for the historical numbers, but it shows that MEGARON Spólka Akcyjna had zł6.01m of debt in September 2020, down from zł8.50m, one year before. However, it also had zł1.82m in cash, and so its net debt is zł4.19m.

A Look At MEGARON Spólka Akcyjna's Liabilities

The latest balance sheet data shows that MEGARON Spólka Akcyjna had liabilities of zł9.72m due within a year, and liabilities of zł10.7m falling due after that. Offsetting these obligations, it had cash of zł1.82m as well as receivables valued at zł8.69m due within 12 months. So its liabilities total zł9.88m more than the combination of its cash and short-term receivables.

MEGARON Spólka Akcyjna has a market capitalization of zł32.9m, 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MEGARON Spólka Akcyjna has a low net debt to EBITDA ratio of only 0.68. And its EBIT covers its interest expense a whopping 32.9 times over. So we're pretty relaxed about its super-conservative use of debt. The good news is that MEGARON Spólka Akcyjna has increased its EBIT by 6.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is MEGARON Spólka Akcyjna's earnings that will influence how the balance sheet holds up in the future. 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's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, MEGARON Spólka Akcyjna recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis MEGARON Spólka Akcyjna's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Considering this range of data points, we think MEGARON Spólka Akcyjna is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example MEGARON Spólka Akcyjna has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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