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David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Materion Company (NYSE: MTRN) uses debt in its business. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first consider both liquidity and debt levels.
Check out our latest review for Materion
How much debt does Materion have?
You can click on the graph below for historical numbers, but it shows Materion had $ 59.3 million in debt as of July 2021, up from $ 151.7 million a year earlier. However, it has $ 24.3 million in cash offsetting that, which leads to net debt of around $ 34.9 million.
Is Materion’s track record healthy?
Zooming in on the latest balance sheet data, we can see that Materion had a liability of US $ 161.2 million due within 12 months and a liability of US $ 298.6 million beyond. In return, he had $ 24.3 million in cash and $ 179.3 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 256.1 million.
Considering that the listed Materion shares are worth a total of US $ 1.46 billion, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Materion has a low net debt to EBITDA ratio of just 0.32. And its EBIT easily covers its interest costs, being 17.5 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Also positive, Materion has increased its EBIT by 22% over the past year, which should make it easier to pay down debt going forward. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Materion’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Materion has recorded free cash flow of 76% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Fortunately, Materion’s impressive interest coverage means it has the upper hand over its debt. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Overall, we don’t think Materion is taking bad risks, as its leverage appears modest. We are therefore not worried about the use of a small leverage on the balance sheet. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 1 warning sign for Materion you must be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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