Stock Analysis

Here's Why MDI Energia (WSE:MDI) Can Afford Some Debt

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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 MDI Energia S.A. (WSE:MDI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does MDI Energia Carry?

As you can see below, MDI Energia had zł34.8m of debt at September 2022, down from zł56.8m a year prior. On the flip side, it has zł7.73m in cash leading to net debt of about zł27.1m.

WSE:MDI Debt to Equity History March 16th 2023

A Look At MDI Energia's Liabilities

Zooming in on the latest balance sheet data, we can see that MDI Energia had liabilities of zł74.5m due within 12 months and liabilities of zł6.72m due beyond that. Offsetting this, it had zł7.73m in cash and zł90.2m in receivables that were due within 12 months. So it can boast zł16.7m more liquid assets than total liabilities.

This excess liquidity suggests that MDI Energia is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. When analysing debt levels, the balance sheet is the obvious place to start. But it is MDI Energia'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.

Over 12 months, MDI Energia made a loss at the EBIT level, and saw its revenue drop to zł209m, which is a fall of 20%. We would much prefer see growth.

Caveat Emptor

While MDI Energia's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost zł3.3m at the EBIT level. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. But we'd be more likely to spend time trying to understand the stock if the company made a profit. So it seems too risky for our taste. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for MDI Energia (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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