The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, M.T.I Wireless Edge Ltd. (LON:MWE) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is M.T.I Wireless Edge's Debt?
As you can see below, M.T.I Wireless Edge had US$602.0k of debt at June 2019, down from US$1.33m a year prior. However, its balance sheet shows it holds US$5.66m in cash, so it actually has US$5.06m net cash.
How Healthy Is M.T.I Wireless Edge's Balance Sheet?
According to the last reported balance sheet, M.T.I Wireless Edge had liabilities of US$8.37m due within 12 months, and liabilities of US$1.51m due beyond 12 months. Offsetting these obligations, it had cash of US$5.66m as well as receivables valued at US$13.3m due within 12 months. So it actually has US$9.09m more liquid assets than total liabilities.
It's good to see that M.T.I Wireless Edge has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, M.T.I Wireless Edge boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that M.T.I Wireless Edge has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if M.T.I Wireless Edge 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. While M.T.I Wireless Edge 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. During the last three years, M.T.I Wireless Edge produced sturdy free cash flow equating to 71% 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.
While we empathize with investors who find debt concerning, you should keep in mind that M.T.I Wireless Edge has net cash of US$5.06m, as well as more liquid assets than liabilities. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't think M.T.I Wireless Edge's use of debt is risky. Given M.T.I Wireless Edge 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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