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.' 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. We can see that Michelmersh Brick Holdings plc (LON:MBH) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Michelmersh Brick Holdings's Debt?
As you can see below, Michelmersh Brick Holdings had UK£10.7m of debt at June 2021, down from UK£23.9m a year prior. But on the other hand it also has UK£14.8m in cash, leading to a UK£4.07m net cash position.
How Strong Is Michelmersh Brick Holdings' Balance Sheet?
According to the last reported balance sheet, Michelmersh Brick Holdings had liabilities of UK£14.1m due within 12 months, and liabilities of UK£24.1m due beyond 12 months. Offsetting this, it had UK£14.8m in cash and UK£11.9m in receivables that were due within 12 months. So its liabilities total UK£11.5m more than the combination of its cash and short-term receivables.
Given Michelmersh Brick Holdings has a market capitalization of UK£129.3m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Michelmersh Brick Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Michelmersh Brick Holdings grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Michelmersh Brick Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Michelmersh Brick Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Michelmersh Brick Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Michelmersh Brick Holdings has UK£4.07m in net cash. The cherry on top was that in converted 122% of that EBIT to free cash flow, bringing in UK£11m. So is Michelmersh Brick Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Michelmersh Brick Holdings has 1 warning sign we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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