Does Motorcar Parts of America (NASDAQ:MPAA) Have A Healthy Balance Sheet?

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 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. As with many other companies Motorcar Parts of America, Inc. (NASDAQ:MPAA) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Motorcar Parts of America

What Is Motorcar Parts of America's Debt?

The image below, which you can click on for greater detail, shows that Motorcar Parts of America had debt of US$148.2m at the end of December 2023, a reduction from US$188.9m over a year. However, it also had US$14.4m in cash, and so its net debt is US$133.9m.

A Look At Motorcar Parts of America's Liabilities

The latest balance sheet data shows that Motorcar Parts of America had liabilities of US$389.5m due within a year, and liabilities of US$324.6m falling due after that. On the other hand, it had cash of US$14.4m and US$118.2m worth of receivables due within a year. So its liabilities total US$581.6m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$146.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Motorcar Parts of America would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Motorcar Parts of America has a quite reasonable net debt to EBITDA multiple of 2.2, its interest cover seems weak, at 0.87. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Pleasingly, Motorcar Parts of America is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 171% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Motorcar Parts of America's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. During the last three years, Motorcar Parts of America burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Motorcar Parts of America's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that Motorcar Parts of America's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 1 warning sign for Motorcar Parts of America you should be aware of.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.