Warren Buffett said: “Volatility is far from synonymous with risk”. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We notice that Macmahon Holdings Limited (ASX: MAH) has debt on its balance sheet. But the most important question is: what risk does this debt create?

What risk does debt entail?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen 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 look at cash and debt levels together.

Check out our latest analysis for Macmahon Holdings

What is the net debt of Macmahon Holdings?

The image below, which you can click for more details, shows that as of December 2020, Macmahon Holdings was in debt of A $ 68.3 million, compared to A $ 17.1 million in one year. However, it has A $ 148.4 million in cash offsetting this, leading to net cash of A $ 80.2 million.

How strong is Macmahon Holdings’ balance sheet?

The latest balance sheet data shows Macmahon Holdings had A $ 269.4 million in liabilities maturing within one year, and A $ 216.4 million in liabilities maturing thereafter. In return, he had A $ 148.4 million in cash and A $ 206.2 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by A $ 131.1 million.

While that might sound like a lot, it’s not that bad since Macmahon Holdings has a market cap of A $ 409.5 million, and could therefore likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky. Despite its notable liabilities, Macmahon Holdings has a net cash flow, so it’s fair to say that it doesn’t have a heavy debt load!

Another good sign is that Macmahon Holdings was able to increase its EBIT by 22% in twelve months, making it easier to repay debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Macmahon Holdings’ ability to maintain a healthy balance sheet going forward. 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 debts; accounting profits are not enough. While Macmahon Holdings has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. Over the past three years, Macmahon Holdings has recorded free cash flow totaling 85% of its EBIT, which is higher than what we usually expected. This puts him in a very strong position to pay off the debt.

In summary

While Macmahon Holdings’ balance sheet is not particularly strong, due to total liabilities it is clearly positive to see that it has net cash of A $ 80.2 million. The icing on the cake was that he converted 85% of that EBIT into free cash flow, bringing in AU $ 48 million. So is Macmahon Holdings’ debt a risk? It does not seem to us. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 2 warning signs for Macmahon Holdings (1 is significant) you must be aware.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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