These 4 Measures Indicate That Poslovni sistem Mercator d.d (LJSE:MELR) Is Using Debt Extensively

By
Simply Wall St
Published
February 02, 2021
LJSE:MELR
Source: Shutterstock

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 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. Importantly, Poslovni sistem Mercator, d.d. (LJSE:MELR) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Poslovni sistem Mercator d.d

How Much Debt Does Poslovni sistem Mercator d.d Carry?

As you can see below, Poslovni sistem Mercator d.d had €557.2m of debt at September 2020, down from €644.5m a year prior. However, it does have €21.4m in cash offsetting this, leading to net debt of about €535.9m.

debt-equity-history-analysis
LJSE:MELR Debt to Equity History February 3rd 2021

A Look At Poslovni sistem Mercator d.d's Liabilities

Zooming in on the latest balance sheet data, we can see that Poslovni sistem Mercator d.d had liabilities of €1.08b due within 12 months and liabilities of €402.3m due beyond that. On the other hand, it had cash of €21.4m and €144.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.32b.

The deficiency here weighs heavily on the €106.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Poslovni sistem Mercator d.d would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Poslovni sistem Mercator d.d's debt to EBITDA ratio (4.5) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that Poslovni sistem Mercator d.d grew its EBIT a smooth 56% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Poslovni sistem Mercator d.d 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Poslovni sistem Mercator d.d actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about Poslovni sistem Mercator d.d's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Poslovni sistem Mercator d.d is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Poslovni sistem Mercator d.d , and understanding them should be part of your investment process.

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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