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 note that Materialise NV (NASDAQ:MTLS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Materialise Carry?
The image below, which you can click on for greater detail, shows that at December 2019 Materialise had debt of €120.0m, up from €99.2m in one year. But it also has €128.9m in cash to offset that, meaning it has €8.95m net cash.
How Healthy Is Materialise's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Materialise had liabilities of €84.0m due within 12 months and liabilities of €122.6m due beyond that. Offsetting this, it had €128.9m in cash and €40.3m in receivables that were due within 12 months. So its liabilities total €37.4m more than the combination of its cash and short-term receivables.
Of course, Materialise has a market capitalization of €602.9m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Materialise boasts net cash, so it's fair to say it does not have a heavy debt load!
It is well worth noting that Materialise's EBIT shot up like bamboo after rain, gaining 43% in the last twelve months. That'll make it easier to manage 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 Materialise'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Materialise 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. Over the last three years, Materialise recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
We could understand if investors are concerned about Materialise's liabilities, but we can be reassured by the fact it has has net cash of €8.95m. And it impressed us with its EBIT growth of 43% over the last year. So we are not troubled with Materialise's debt use. 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. Take risks, for example - Materialise has 4 warning signs we think 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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