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 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, Matrix Service Company (NASDAQ:MTRX) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Matrix Service's Net Debt?
As you can see below, at the end of June 2020, Matrix Service had US$9.21m of debt, up from US$5.35m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$100.0m in cash, so it actually has US$90.8m net cash.
How Healthy Is Matrix Service's Balance Sheet?
According to the last reported balance sheet, Matrix Service had liabilities of US$175.9m due within 12 months, and liabilities of US$33.5m due beyond 12 months. Offsetting these obligations, it had cash of US$100.0m as well as receivables valued at US$224.1m due within 12 months. So it can boast US$114.8m more liquid assets than total liabilities.
This luscious liquidity implies that Matrix Service's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Matrix Service boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Matrix Service's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Matrix Service'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. Matrix Service may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Matrix Service actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case Matrix Service has US$90.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 182% of that EBIT to free cash flow, bringing in US$26m. So we don't think Matrix Service's use of debt is 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. To that end, you should be aware of the 1 warning sign we've spotted with Matrix Service .
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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