David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Minerals Technologies Inc. (NYSE:MTX) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Minerals Technologies’s Debt?
The chart below, which you can click on for greater detail, shows that Minerals Technologies had US$941.9m in debt in December 2020; about the same as the year before. However, it does have US$371.8m in cash offsetting this, leading to net debt of about US$570.1m.
A Look At Minerals Technologies’ Liabilities
According to the last reported balance sheet, Minerals Technologies had liabilities of US$295.8m due within 12 months, and liabilities of US$1.41b due beyond 12 months. Offsetting these obligations, it had cash of US$371.8m as well as receivables valued at US$369.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$969.9m.
Minerals Technologies has a market capitalization of US$2.62b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Minerals Technologies’s net debt is sitting at a very reasonable 1.9 times its EBITDA, while its EBIT covered its interest expense just 5.5 times last year. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. The bad news is that Minerals Technologies saw its EBIT decline by 10% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Minerals Technologies’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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Minerals Technologies recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
When it comes to the balance sheet, the standout positive for Minerals Technologies was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren’t so heartening. For example, its EBIT growth rate makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Minerals Technologies’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Be aware that Minerals Technologies is showing 1 warning sign in our investment analysis , you should know about…
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.
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