Here's Why MFO Spólka Akcyjna (WSE:MFO) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that MFO Spólka Akcyjna (WSE:MFO) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, 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.

See our latest analysis for MFO Spólka Akcyjna

What Is MFO Spólka Akcyjna's Net Debt?

As you can see below, MFO Spólka Akcyjna had zł47.9m of debt at December 2020, down from zł61.2m a year prior. However, it also had zł33.1m in cash, and so its net debt is zł14.8m.

How Healthy Is MFO Spólka Akcyjna's Balance Sheet?

We can see from the most recent balance sheet that MFO Spólka Akcyjna had liabilities of zł83.0m falling due within a year, and liabilities of zł41.1m due beyond that. On the other hand, it had cash of zł33.1m and zł34.1m worth of receivables due within a year. So its liabilities total zł56.9m more than the combination of its cash and short-term receivables.

Given MFO Spólka Akcyjna has a market capitalization of zł284.8m, 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.

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.

MFO Spólka Akcyjna has a low net debt to EBITDA ratio of only 0.42. And its EBIT covers its interest expense a whopping 38.2 times over. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that MFO Spólka Akcyjna saw its EBIT decline by 7.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since MFO Spólka Akcyjna 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 we always check how much of that EBIT is translated into free cash flow. In the last three years, MFO Spólka Akcyjna created free cash flow amounting to 4.1% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

MFO Spólka Akcyjna's interest cover was a real positive on this analysis, as was its net debt to EBITDA. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. Looking at all this data makes us feel a little cautious about MFO Spólka Akcyjna's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should be aware of the 2 warning signs we've spotted with MFO Spólka Akcyjna .

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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