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 the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is MultiChoice Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 MultiChoice Group had R1.65b of debt, an increase on R572.0m, over one year. But it also has R7.31b in cash to offset that, meaning it has R5.66b net cash.
How Healthy Is MultiChoice Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that MultiChoice Group had liabilities of R22.7b due within 12 months and liabilities of R12.9b due beyond that. On the other hand, it had cash of R7.31b and R4.38b worth of receivables due within a year. So its liabilities total R24.0b more than the combination of its cash and short-term receivables.
MultiChoice Group has a market capitalization of R51.5b, 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 good is that MultiChoice Group grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MultiChoice Group 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. MultiChoice Group 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. During the last three years, MultiChoice Group produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
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 R5.66b. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in R8.5b. 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. We've identified 2 warning signs with MultiChoice Group , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
Valuation is complex, but we're helping make it simple.
Find out whether MultiChoice Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.