Mercer International (NASDAQ:MERC) Has A Somewhat Strained Balance Sheet

By
Simply Wall St
Published
January 24, 2022
NasdaqGS:MERC
Source: Shutterstock

Warren Buffett famously said, '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, Mercer International Inc. (NASDAQ:MERC) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Mercer International

What Is Mercer International's Net Debt?

As you can see below, Mercer International had US$1.16b of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$338.7m in cash offsetting this, leading to net debt of about US$823.6m.

debt-equity-history-analysis
NasdaqGS:MERC Debt to Equity History January 24th 2022

How Strong Is Mercer International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mercer International had liabilities of US$256.5m due within 12 months and liabilities of US$1.35b due beyond that. On the other hand, it had cash of US$338.7m and US$253.7m worth of receivables due within a year. So its liabilities total US$1.01b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$754.2m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Mercer International's net debt is sitting at a very reasonable 2.3 times its EBITDA, while its EBIT covered its interest expense just 3.2 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We also note that Mercer International improved its EBIT from a last year's loss to a positive US$233m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Mercer International's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Mercer International reported free cash flow worth 10% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Mercer International's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least its EBIT growth rate is not so bad. Overall, it seems to us that Mercer International's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Be aware that Mercer International is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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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