Is MRC Global (NYSE:MRC) using too much debt?

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Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, MRC Global Inc. (NYSE:MRC) is in debt. But the more important question is: what risk does this debt create?

When is debt a problem?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for MRC Global

What is MRC Global’s debt?

You can click on the graph below for historical numbers, but it shows that in June 2022, MRC Global had debt of $356.0 million, an increase from $297.0 million, on a year. However, since he has a cash reserve of $21.0 million, his net debt is lower, at around $335.0 million.

NYSE: MRC Debt to Equity Ratio History August 29, 2022

How strong is MRC Global’s balance sheet?

According to the last published balance sheet, MRC Global had liabilities of US$549.0 million due within 12 months and liabilities of US$613.0 million due beyond 12 months. In return, it had $21.0 million in cash and $489.0 million in receivables due within 12 months. Thus, its liabilities total $652.0 million more than the combination of its cash and short-term receivables.

This shortfall is sizable relative to its market capitalization of US$867.8 million, so it suggests shareholders should monitor MRC Global’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

While we are not concerned about MRC Global’s net debt to EBITDA ratio of 3.5, we believe its extremely low interest coverage of 2.5 times is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. The good news is that MRC Global has grown its EBIT by 96% smoothly over the last twelve months. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine MRC Global’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, MRC Global has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

MRC Global’s ability to convert EBIT to free cash flow and its rate of EBIT growth has given us comfort in its ability to manage its debt. But truth be told, his coverage of interest had us biting our nails. Given this range of data points, we believe MRC Global is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Be aware that MRC Global displays 1 warning sign in our investment analysis you should know…

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

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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