Is Calgro M3 Holdings (JSE:CGR) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Calgro M3 Holdings Limited (JSE:CGR) does use debt in its business. But the real question is whether this debt is making the company risky.

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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Calgro M3 Holdings

What Is Calgro M3 Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Calgro M3 Holdings had R944.2m of debt in February 2021, down from R1.06b, one year before. However, it also had R154.6m in cash, and so its net debt is R789.6m.

How Healthy Is Calgro M3 Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Calgro M3 Holdings had liabilities of R1.43b due within 12 months and liabilities of R208.6m due beyond that. Offsetting this, it had R154.6m in cash and R1.36b in receivables that were due within 12 months. So it has liabilities totalling R125.4m more than its cash and near-term receivables, combined.

Calgro M3 Holdings has a market capitalization of R344.8m, 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.

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.

Weak interest cover of 0.73 times and a disturbingly high net debt to EBITDA ratio of 26.7 hit our confidence in Calgro M3 Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Notably, Calgro M3 Holdings's EBIT was pretty flat over the last year, which isn't ideal given the debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Calgro M3 Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Calgro M3 Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Calgro M3 Holdings's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. We think that Calgro M3 Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For instance, we've identified 5 warning signs for Calgro M3 Holdings (2 can't be ignored) you should be aware of.

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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This article by Simply Wall St is general in nature. 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.
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