These 4 Measures Indicate That Metrofile Holdings (JSE:MFL) Is Using Debt Extensively

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.' 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 Metrofile Holdings Limited (JSE:MFL) makes use of debt. But is this debt a concern to shareholders?

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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. 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.

What Is Metrofile Holdings's Debt?

As you can see below, at the end of December 2024, Metrofile Holdings had R603.5m of debt, up from R578.7m a year ago. Click the image for more detail. However, because it has a cash reserve of R82.3m, its net debt is less, at about R521.2m.

A Look At Metrofile Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Metrofile Holdings had liabilities of R215.8m due within 12 months and liabilities of R731.5m due beyond that. Offsetting this, it had R82.3m in cash and R317.0m in receivables that were due within 12 months. So it has liabilities totalling R547.9m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of R886.6m, so it does suggest shareholders should keep an eye on Metrofile Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

View our latest analysis for Metrofile Holdings

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Metrofile Holdings's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 2.6 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Shareholders should be aware that Metrofile Holdings's EBIT was down 24% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Metrofile Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Metrofile Holdings produced sturdy free cash flow equating to 56% 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.

Our View

Mulling over Metrofile Holdings's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Metrofile Holdings has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Metrofile Holdings is showing 4 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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.