Does Montauk Renewables (NASDAQ:MNTK) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Montauk Renewables, Inc. (NASDAQ:MNTK) makes use of 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. If things get really bad, the lenders can take control of the business. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Montauk Renewables

What Is Montauk Renewables's Debt?

The image below, which you can click on for greater detail, shows that Montauk Renewables had debt of US$65.5m at the end of September 2023, a reduction from US$73.3m over a year. However, it does have US$74.3m in cash offsetting this, leading to net cash of US$8.83m.

How Strong Is Montauk Renewables' Balance Sheet?

The latest balance sheet data shows that Montauk Renewables had liabilities of US$30.2m due within a year, and liabilities of US$72.1m falling due after that. Offsetting this, it had US$74.3m in cash and US$28.2m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Montauk Renewables' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$678.5m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Montauk Renewables has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Montauk Renewables's EBIT was down 41% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Montauk Renewables can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Montauk Renewables 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. Over the most recent two years, Montauk Renewables recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Montauk Renewables has net cash of US$8.83m, as well as more liquid assets than liabilities. So we don't have any problem with Montauk Renewables's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Montauk Renewables , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.