David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Metarock Group Limited (ASX:MYE) uses debt in its business. But the more important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Metarock Group
What is the Metarock Group’s net debt?
You can click on the graph below for historical figures, but it shows that in December 2021 Metarock Group had debt of A$67.3 million, an increase from zero, year on year. However, he also had A$13.2 million in cash, so his net debt is A$54.2 million.
How healthy is Metarock’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Metarock Group had liabilities of A$138.7 million due within 12 months and liabilities of A$44.1 million due beyond. On the other hand, it had cash of A$13.2 million and A$73.1 million of receivables due within one year. It therefore has liabilities totaling A$96.7 million more than its cash and short-term receivables, combined.
The deficiency here weighs heavily on the A$49.1 million business itself, like a child struggling under the weight of a huge backpack full of books, his gym gear and a trumpet. So we definitely think shareholders need to watch this one closely. Ultimately, the Metarock Group would likely need a major recapitalization if its creditors were to demand repayment.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
While we are not concerned about Metarock Group’s net debt to EBITDA ratio of 4.3, we believe its extremely low interest coverage of 2.0 times is a sign of high leverage. This is largely due to the company’s large amortization charges, which no doubt means that its EBITDA is a very generous measure of earnings, and that its debt may be heavier than it first appears. on board. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. Worse still, Metarock Group has seen its EBIT drop to 76% in the last 12 months. If earnings continue to follow this trajectory, paying off this debt will be more difficult than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Metarock Group’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Metarock Group has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
To be frank, Metarock Group’s EBIT growth rate and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Overall, it seems to us that Metarock Group’s balance sheet is really a risk for the company. We are therefore almost as wary of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Metarock Group displays 6 warning signs in our investment analysis and 1 of them cannot be ignored…
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
Comments are closed.