Is M / I Homes (NYSE: MHO) a risky investment?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Mostly, M / I Homes, Inc. (NYSE: MHO) is in debt. But does this debt concern shareholders?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
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What is M / I Homes’ net debt?
As you can see below, M / I Homes owed US $ 813.2 million in debt as of March 2021, which is roughly the same as the year before. You can click on the graph for more details. However, because he has a cash reserve of $ 292.4 million, his net debt is less, at around $ 520.8 million.
How strong is M / I Homes’ balance sheet?
We can see from the most recent balance sheet that M / I Homes had liabilities of US $ 417.0 million due within one year and liabilities of US $ 939.2 million due within one year. -of the. In compensation for these obligations, it had cash of US $ 292.4 million as well as receivables valued at US $ 22.2 million due within 12 months. It therefore has liabilities totaling US $ 1.04 billion more than its cash and short-term receivables combined.
This is a mountain of leverage compared to its market capitalization of US $ 1.66 billion. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
M / I Homes has a low net debt to EBITDA ratio of just 1.3. And its EBIT covers its interest costs a whopping 129 times. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are happy to report that M / I Homes has increased its EBIT by 91%, reducing the specter of future debt repayments. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the future profitability of the business will decide whether M / I Homes can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, M / I Homes’ free cash flow has been 42% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
Fortunately, M / I Homes’ impressive interest coverage means they have the upper hand on their debt. But, on a darker note, we’re a little concerned with its total liability level. All these things considered, it looks like M / I Homes can comfortably manage their current debt levels. Of course, while this leverage can improve returns on equity, it brings more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – M / I Homes a 4 warning signs we think you should be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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