Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Murgitroyd Group PLC (LON:MUR) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Murgitroyd Group's Debt?
As you can see below, Murgitroyd Group had UK£198.0k of debt at November 2018, down from UK£275.0k a year prior. But it also has UK£2.23m in cash to offset that, meaning it has UK£2.03m net cash.
How Strong Is Murgitroyd Group's Balance Sheet?
According to the last reported balance sheet, Murgitroyd Group had liabilities of UK£7.25m due within 12 months, and liabilities of UK£91.0k due beyond 12 months. On the other hand, it had cash of UK£2.23m and UK£16.9m worth of receivables due within a year. So it actually has UK£11.8m more liquid assets than total liabilities.
This surplus suggests that Murgitroyd Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Murgitroyd Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Murgitroyd Group grew its EBIT by 2.7% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Murgitroyd Group 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Murgitroyd Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Murgitroyd Group recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Murgitroyd Group has net cash of UK£2.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in UK£1.6m. So we don't think Murgitroyd Group's use of debt is risky. Given Murgitroyd Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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