David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Mastercard Incorporated (NYSE:MA) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Mastercard
How Much Debt Does Mastercard Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Mastercard had debt of US$12.7b, up from US$8.53b in one year. However, it also had US$10.6b in cash, and so its net debt is US$2.08b.
How Healthy Is Mastercard‘s Balance Sheet?
The latest balance sheet data shows that Mastercard had liabilities of US$11.8b due within a year, and liabilities of US$15.2b falling due after that. Offsetting this, it had US$10.6b in cash and US$4.35b in receivables that were due within 12 months. So its liabilities total US$12.1b more than the combination of its cash and short-term receivables.
Given Mastercard has a humongous market capitalization of US$363.7b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Mastercard has a very light debt load indeed.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Mastercard has a low net debt to EBITDA ratio of only 0.24. And its EBIT easily covers its interest expense, being 22.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Mastercard‘s EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Mastercard‘s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Mastercard recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Happily, Mastercard‘s impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. When we consider the range of factors above, it looks like Mastercard is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For instance, we’ve identified 1 warning sign for Mastercard that 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.
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