Motus Holdings (JSE:MTH) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Motus Holdings Limited (JSE:MTH) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Motus Holdings

What Is Motus Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Motus Holdings had debt of R26.8b, up from R11.0b in one year. However, it also had R2.04b in cash, and so its net debt is R24.7b.

A Look At Motus Holdings' Liabilities

We can see from the most recent balance sheet that Motus Holdings had liabilities of R32.8b falling due within a year, and liabilities of R16.0b due beyond that. Offsetting this, it had R2.04b in cash and R6.76b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R40.1b.

The deficiency here weighs heavily on the R17.7b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Motus Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Motus Holdings's debt is 3.4 times its EBITDA, and its EBIT cover its interest expense 4.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that Motus Holdings grew its EBIT at 13% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Motus Holdings'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Motus Holdings's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Motus Holdings's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. We're quite clear that we consider Motus Holdings to be really rather risky, as a result of its balance sheet health. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Motus Holdings (including 1 which is a bit concerning) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.