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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Monadelphous Group Limited (ASX:MND) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Monadelphous Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Monadelphous Group had AU$3.52m of debt, an increase on AU$3.30m, over one year. But it also has AU$208.3m in cash to offset that, meaning it has AU$204.8m net cash.
How Strong Is Monadelphous Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Monadelphous Group had liabilities of AU$249.2m due within 12 months and liabilities of AU$80.5m due beyond that. Offsetting this, it had AU$208.3m in cash and AU$289.8m in receivables that were due within 12 months. So it can boast AU$168.4m 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. Simply put, the fact that Monadelphous Group has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Monadelphous Group if management cannot prevent a repeat of the 31% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Monadelphous Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Monadelphous 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, Monadelphous Group recorded free cash flow worth 60% 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 Monadelphous Group has net cash of AU$204.8m, as well as more liquid assets than liabilities. So we are not troubled with Monadelphous Group'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. Be aware that Monadelphous Group is showing 1 warning sign in our investment analysis , you should know about...
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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