Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Macquarie Telecom Group Limited (ASX:MAQ) uses debt in its business. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
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How much debt does Macquarie Telecom Group have?
You can click on the graph below for historical figures, but it shows Macquarie Telecom Group had A$126.0 million in debt in June 2022, up from A$132.0 million a year earlier. On the other hand, he has A$2.95 million in cash, resulting in a net debt of around A$123.0 million.
How healthy is Macquarie Telecom Group’s balance sheet?
According to the latest published balance sheet, Macquarie Telecom Group had liabilities of A$61.6 million due within 12 months and liabilities of A$265.3 million due beyond 12 months. In compensation for these obligations, it had cash of 2.95 million Australian dollars as well as receivables valued at 38.5 million Australian dollars maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of A$285.4 million.
While that might sound like a lot, it’s not too bad since Macquarie Telecom Group has a market capitalization of A$1.28 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Macquarie Telecom Group has net debt worth 2.0x EBITDA, which isn’t too much, but its interest coverage looks a bit low, with EBIT at just 2.6x operating expenses. ‘interests. 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. Macquarie Telecom Group has increased its EBIT by 3.7% over the past year. While that barely brings us down, it’s a positive when it comes to debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Macquarie Telecom 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.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Macquarie Telecom Group has burned through a lot of cash. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
Reflecting on Macquarie Telecom Group’s attempt to convert EBIT to free cash flow, we are certainly not enthusiastic. That said, its ability to grow its EBIT is not such a concern. Looking at the balance sheet and taking all of these factors into account, we think the debt makes Macquarie Telecom Group’s shares a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for Macquarie Telecom Group (1 is a bit worrying!) which you should be aware of before investing here.
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.
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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.
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