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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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Mitchells & Butlers plc (LON:MAB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Mitchells & Butlers
How Much Debt Does Mitchells & Butlers Carry?
The chart below, which you can click on for greater detail, shows that Mitchells & Butlers had UK£2.19b in debt in April 2019; about the same as the year before. On the flip side, it has UK£265.0m in cash leading to net debt of about UK£1.92b.
How Strong Is Mitchells & Butlers's Balance Sheet?
We can see from the most recent balance sheet that Mitchells & Butlers had liabilities of UK£673.0m falling due within a year, and liabilities of UK£2.42b due beyond that. On the other hand, it had cash of UK£265.0m and UK£56.0m worth of receivables due within a year. So it has liabilities totalling UK£2.78b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the UK£1.61b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Mitchells & Butlers would likely require a major re-capitalisation if it had to pay its creditors today.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).