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, Mastercard Incorporated (NYSE:MA) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. 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.
What Is Mastercard’s Debt?
As you can see below, at the end of September 2021, Mastercard had US$13.9b of debt, up from US$12.6b a year ago. Click the image for more detail. On the flip side, it has US$6.92b in cash leading to net debt of about US$6.95b.
A Look At Mastercard’s Liabilities
Zooming in on the latest balance sheet data, we can see that Mastercard had liabilities of US$11.6b due within 12 months and liabilities of US$17.0b due beyond that. Offsetting this, it had US$6.92b in cash and US$3.68b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.0b.
Given Mastercard has a humongous market capitalization of US$363.2b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Mastercard’s net debt is only 0.68 times its EBITDA. And its EBIT easily covers its interest expense, being 22.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Mastercard grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Mastercard can strengthen its balance sheet over time.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Mastercard recorded free cash flow worth 77% 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.
Happily, Mastercard’s impressive interest cover implies it has the upper hand on its debt. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Mastercard seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt.
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