Here's Why Montrose Environmental Group (NYSE:MEG) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Montrose Environmental Group, Inc. (NYSE:MEG) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Montrose Environmental Group

What Is Montrose Environmental Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Montrose Environmental Group had US$212.4m of debt, an increase on US$169.1m, over one year. However, it does have US$18.3m in cash offsetting this, leading to net debt of about US$194.1m.

How Healthy Is Montrose Environmental Group's Balance Sheet?

According to the last reported balance sheet, Montrose Environmental Group had liabilities of US$131.7m due within 12 months, and liabilities of US$270.5m due beyond 12 months. Offsetting these obligations, it had cash of US$18.3m as well as receivables valued at US$208.9m due within 12 months. So it has liabilities totalling US$175.0m more than its cash and near-term receivables, combined.

Of course, Montrose Environmental Group has a market capitalization of US$934.1m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Montrose Environmental Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Montrose Environmental Group wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to US$662m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Montrose Environmental Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$18m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$19m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Montrose Environmental Group that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.