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. As with many other companies MultiChoice Group Limited (JSE:MCG) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.
What Is MultiChoice Group's Debt?
The image below, which you can click on for greater detail, shows that at March 2021 MultiChoice Group had debt of R1.90b, up from R263.0m in one year. However, it does have R8.54b in cash offsetting this, leading to net cash of R6.64b.
A Look At MultiChoice Group's Liabilities
Zooming in on the latest balance sheet data, we can see that MultiChoice Group had liabilities of R18.6b due within 12 months and liabilities of R14.3b due beyond that. On the other hand, it had cash of R8.54b and R3.35b worth of receivables due within a year. So its liabilities total R20.9b more than the combination of its cash and short-term receivables.
MultiChoice Group has a market capitalization of R51.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, MultiChoice Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, MultiChoice Group grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MultiChoice Group'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MultiChoice Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, MultiChoice Group produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Although MultiChoice Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R6.64b. And it impressed us with its EBIT growth of 27% over the last year. So we don't think MultiChoice Group's use of debt is risky. 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. Be aware that MultiChoice Group is showing 1 warning sign in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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