Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Medica Group Plc (LON:MGP) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Medica Group's Net Debt?
The chart below, which you can click on for greater detail, shows that Medica Group had UK£12.3m in debt in December 2019; about the same as the year before. But on the other hand it also has UK£16.6m in cash, leading to a UK£4.24m net cash position.
How Strong Is Medica Group's Balance Sheet?
We can see from the most recent balance sheet that Medica Group had liabilities of UK£4.80m falling due within a year, and liabilities of UK£13.2m due beyond that. On the other hand, it had cash of UK£16.6m and UK£10.2m worth of receivables due within a year. So it actually has UK£8.73m more liquid assets than total liabilities.
This surplus suggests that Medica Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Medica Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Medica Group has increased its EBIT by 5.8% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Medica 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 report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Medica Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Medica Group produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Medica Group has UK£4.24m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of UK£6.9m, being 67% of its EBIT. So we don't think Medica Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Medica Group that you should be aware of before investing here.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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