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 Mercury Systems, Inc. (NASDAQ:MRCY) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Mercury Systems
What Is Mercury Systems's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Mercury Systems had US$578.0m of debt, an increase on US$511.5m, over one year. However, it does have US$89.4m in cash offsetting this, leading to net debt of about US$488.7m.
A Look At Mercury Systems' Liabilities
According to the last reported balance sheet, Mercury Systems had liabilities of US$205.3m due within 12 months, and liabilities of US$654.6m due beyond 12 months. Offsetting this, it had US$89.4m in cash and US$480.0m in receivables that were due within 12 months. So it has liabilities totalling US$290.6m more than its cash and near-term receivables, combined.
Of course, Mercury Systems has a market capitalization of US$2.25b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Mercury Systems can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Mercury Systems made a loss at the EBIT level, and saw its revenue drop to US$927m, which is a fall of 6.4%. We would much prefer see growth.
Caveat Emptor
Over the last twelve months Mercury Systems produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$33m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$34m of cash over the last year. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Mercury Systems , and understanding them should be part of your investment process.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.