Here's Why Merlin Group (WSE:MRG) Can Afford Some 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. We note that Merlin Group S.A. (WSE:MRG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Merlin Group

How Much Debt Does Merlin Group Carry?

The image below, which you can click on for greater detail, shows that Merlin Group had debt of zł9.01m at the end of March 2021, a reduction from zł43.4m over a year. Net debt is about the same, since the it doesn't have much cash.

A Look At Merlin Group's Liabilities

According to the last reported balance sheet, Merlin Group had liabilities of zł11.6m due within 12 months, and liabilities of zł3.85m due beyond 12 months. Offsetting these obligations, it had cash of zł54.3k as well as receivables valued at zł830.4k due within 12 months. So it has liabilities totalling zł14.6m more than its cash and near-term receivables, combined.

Given Merlin Group has a market capitalization of zł82.3m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Merlin Group 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.

In the last year Merlin Group had a loss before interest and tax, and actually shrunk its revenue by 45%, to zł30m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Merlin Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost zł6.3m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through zł9.0m of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Merlin Group (at least 3 which don't sit too well with us) , and understanding them should be part of your investment process.

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. 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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