Is Megaport (ASX:MP1) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Megaport Limited (ASX:MP1) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Megaport

What Is Megaport's Net Debt?

As you can see below, at the end of June 2020, Megaport had AU$8.79m of debt, up from AU$2.58m a year ago. Click the image for more detail. But it also has AU$167.2m in cash to offset that, meaning it has AU$158.4m net cash.

How Healthy Is Megaport's Balance Sheet?

We can see from the most recent balance sheet that Megaport had liabilities of AU$24.0m falling due within a year, and liabilities of AU$12.1m due beyond that. On the other hand, it had cash of AU$167.2m and AU$11.6m worth of receivables due within a year. So it can boast AU$142.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Megaport could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Megaport boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Megaport can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Megaport reported revenue of AU$58m, which is a gain of 65%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is Megaport?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Megaport had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$49.9m and booked a AU$47.7m accounting loss. But at least it has AU$158.4m on the balance sheet to spend on growth, near-term. Megaport's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Megaport you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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