We Think Mesa Laboratories (NASDAQ:MLAB) Can Stay On Top Of Its Debt

Simply Wall St · 10/17 10:23

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Mesa Laboratories, Inc. (NASDAQ:MLAB) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Mesa Laboratories

What Is Mesa Laboratories's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Mesa Laboratories had debt of US$212.2m, up from US$175.5m in one year. However, because it has a cash reserve of US$30.0m, its net debt is less, at about US$182.3m.

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NasdaqGS:MLAB Debt to Equity History October 17th 2024

A Look At Mesa Laboratories' Liabilities

We can see from the most recent balance sheet that Mesa Laboratories had liabilities of US$54.9m falling due within a year, and liabilities of US$234.8m due beyond that. Offsetting this, it had US$30.0m in cash and US$35.6m in receivables that were due within 12 months. So its liabilities total US$224.1m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Mesa Laboratories has a market capitalization of US$708.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

While Mesa Laboratories's debt to EBITDA ratio (4.6) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, Mesa Laboratories boosted its EBIT by a silky 48% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Mesa Laboratories's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Mesa Laboratories actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Mesa Laboratories's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Mesa Laboratories can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Even though Mesa Laboratories lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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.