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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that MasterCraft Boat Holdings, Inc. (NASDAQ:MCFT) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
What Is MasterCraft Boat Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 MasterCraft Boat Holdings had US$125.9m of debt, an increase on US$86.0m, over one year. However, it also had US$5.65m in cash, and so its net debt is US$120.3m.
A Look At MasterCraft Boat Holdings's Liabilities
We can see from the most recent balance sheet that MasterCraft Boat Holdings had liabilities of US$73.7m falling due within a year, and liabilities of US$119.6m due beyond that. Offsetting this, it had US$5.65m in cash and US$18.1m in receivables that were due within 12 months. So it has liabilities totalling US$169.6m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$277.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
MasterCraft Boat Holdings's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 11.8 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, MasterCraft Boat Holdings grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if MasterCraft Boat Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, MasterCraft Boat Holdings produced sturdy free cash flow equating to 67% 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.
The good news is that MasterCraft Boat Holdings's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like MasterCraft Boat Holdings is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. We'd be motivated to research the stock further if we found out that MasterCraft Boat Holdings insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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