U.S. Markets open in 2 hrs 43 mins

Is Megaport (ASX:MP1) Using Debt In A Risky Way?

Simply Wall St

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. 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. As with many other companies Megaport Limited (ASX:MP1) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Megaport

What Is Megaport's Net Debt?

As you can see below, at the end of June 2019, Megaport had AU$2.56m of debt, up from AU$59.0k a year ago. Click the image for more detail. But on the other hand it also has AU$75.2m in cash, leading to a AU$72.6m net cash position.

ASX:MP1 Historical Debt, October 26th 2019

How Healthy Is Megaport's Balance Sheet?

The latest balance sheet data shows that Megaport had liabilities of AU$14.2m due within a year, and liabilities of AU$2.12m falling due after that. On the other hand, it had cash of AU$75.2m and AU$7.95m worth of receivables due within a year. So it actually has AU$66.8m more liquid assets than total liabilities.

This surplus suggests that Megaport has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Megaport boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Megaport'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.

Over 12 months, Megaport reported revenue of AU$35m, which is a gain of 78%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is Megaport?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Megaport had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through AU$46m of cash and made a loss of AU$34m. But at least it has AU$72.6m on the balance sheet to spend on growth, near-term. Megaport's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. For riskier companies like Megaport I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.