Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital.” It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Like many other companies MTN Group Limited (JSE: MTN) uses debt. But does this debt worry shareholders?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
See our latest analysis for MTN Group
What is the debt of the MTN group?
You can click on the graph below for historical figures, but it shows that MTN Group had R90.8 billion in debt in June 2021, up from R112.9 billion a year earlier. On the other hand, he has 36.9 billion Rand in cash, resulting in a net debt of around 53.9 billion Rand.
A look at the liabilities of the MTN group
Zooming in on the latest balance sheet data, we can see that MTN Group had liabilities of R108.6 billion due within 12 months and R129.8 billion liabilities beyond. In return, he had R36.9 billion in cash and R32.1 billion in receivables due within 12 months. It therefore has liabilities totaling R169.4 billion more than its cash and short-term receivables combined.
MTN Group has a very large market cap of R310.6b, so it could most likely raise cash to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While MTN Group’s low debt-to-EBITDA ratio of 0.72 suggests only a modest use of debt, the fact that EBIT only covered interest expense 4.0 times last year makes us reflect. We therefore recommend that you keep a close eye on the impact of financing costs on the business. We note that MTN Group has increased its EBIT by 24% over the past year, which should make it easier to repay debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But it is future profits, more than anything, that will determine MTN 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 Analyst Profit Forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, MTN Group’s free cash flow has stood at 44% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
MTN Group’s EBIT growth rate was a real advantage in this analysis, as was its net debt to EBITDA. That said, its interest coverage does make us somewhat aware of potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that MTN Group is managing its debt quite well. But beware: we believe debt levels are high enough to warrant continued monitoring. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 3 warning signs for MTN Group which you should know before investing here.
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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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.