Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Macmahon Holdings Limited (ASX:MAH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Macmahon Holdings

How Much Debt Does Macmahon Holdings Carry?

As you can see below, at the end of June 2021, Macmahon Holdings had AU$97.9m of debt, up from AU$18.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds AU$182.1m in cash, so it actually has AU$84.1m net cash. debt-equity-history-analysis

How Healthy Is Macmahon Holdings' Balance Sheet?

The latest balance sheet data shows that Macmahon Holdings had liabilities of AU$400.0m due within a year, and liabilities of AU$207.6m falling due after that. Offsetting this, it had AU$182.1m in cash and AU$241.7m in receivables that were due within 12 months. So it has liabilities totalling AU$183.8m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Macmahon Holdings has a market capitalization of AU$493.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Macmahon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!



Macmahon Holdings grew its EBIT by 5.5% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Macmahon Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this freereport showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Macmahon Holdings 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. Over the most recent three years, Macmahon Holdings recorded free cash flow worth 80% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Macmahon Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$84.1m. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in AU$29m. So we don't have any problem with Macmahon Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that  Macmahon Holdings is showing  3 warning signs in our investment analysis, and 1 of those is a bit concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this freelist 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.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.