Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Monadelphous Group Limited (ASX:MND) makes use of debt. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Monadelphous Group's Net Debt?
As you can see below, at the end of June 2019, Monadelphous Group had AU$3.30m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has AU$164.0m in cash, leading to a AU$160.7m net cash position.
How Strong Is Monadelphous Group's Balance Sheet?
The latest balance sheet data shows that Monadelphous Group had liabilities of AU$258.3m due within a year, and liabilities of AU$32.0m falling due after that. Offsetting this, it had AU$164.0m in cash and AU$352.4m in receivables that were due within 12 months. So it actually has AU$226.2m more liquid assets than total liabilities.
This surplus suggests that Monadelphous Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Monadelphous Group boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Monadelphous Group's load is not too heavy, because its EBIT was down 25% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Monadelphous 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. Monadelphous 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. Looking at the most recent three years, Monadelphous Group recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Monadelphous Group has net cash of AU$160.7m, as well as more liquid assets than liabilities. So we are not troubled with Monadelphous Group's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Monadelphous Group's earnings per share history for free.
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.
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