These 4 Measures Indicate That MasterCraft Boat Holdings (NASDAQ:MCFT) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies MasterCraft Boat Holdings, Inc. (NASDAQ:MCFT) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for MasterCraft Boat Holdings

What Is MasterCraft Boat Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that MasterCraft Boat Holdings had debt of US$84.4m at the end of October 2021, a reduction from US$96.7m over a year. However, it also had US$11.7m in cash, and so its net debt is US$72.8m.

A Look At MasterCraft Boat Holdings' Liabilities

The latest balance sheet data shows that MasterCraft Boat Holdings had liabilities of US$75.4m due within a year, and liabilities of US$86.1m falling due after that. Offsetting these obligations, it had cash of US$11.7m as well as receivables valued at US$20.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$129.8m.

While this might seem like a lot, it is not so bad since MasterCraft Boat Holdings has a market capitalization of US$549.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

MasterCraft Boat Holdings has a low net debt to EBITDA ratio of only 0.79. And its EBIT easily covers its interest expense, being 29.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that MasterCraft Boat Holdings grew its EBIT by 161% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if MasterCraft Boat Holdings 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, MasterCraft Boat Holdings recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

MasterCraft Boat Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Taking all this data into account, it seems to us that MasterCraft Boat Holdings takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for MasterCraft Boat Holdings (of which 1 is significant!) you should know about.

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.