Yahoo Finance Does Michael Hill International (ASX:MHJ) Have A Healthy Balance Sheet?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Michael Hill International Limited (ASX:MHJ) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Michael Hill International
What Is Michael Hill International's Debt?
The image below, which you can click on for greater detail, shows that Michael Hill International had debt of AU$10.7m at the end of June 2020, a reduction from AU$33.0m over a year. But on the other hand it also has AU$11.2m in cash, leading to a AU$489.0k net cash position.
How Strong Is Michael Hill International's Balance Sheet?
According to the last reported balance sheet, Michael Hill International had liabilities of AU$159.4m due within 12 months, and liabilities of AU$188.4m due beyond 12 months. On the other hand, it had cash of AU$11.2m and AU$28.2m worth of receivables due within a year. So its liabilities total AU$308.4m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the AU$205.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Michael Hill International would likely require a major re-capitalisation if it had to pay its creditors today. Given that Michael Hill International has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
Unfortunately, Michael Hill International's EBIT flopped 15% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Michael Hill International'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Michael Hill International may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Michael Hill International actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While Michael Hill International does have more liabilities than liquid assets, it also has net cash of AU$489.0k. And it impressed us with free cash flow of AU$66m, being 130% of its EBIT. Despite the cash, we do find Michael Hill International's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Michael Hill International , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
This article by Simply Wall St is general in nature. 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.
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