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These 4 Measures Indicate That M.D.C. Holdings (NYSE:MDC) Is Using Debt Reasonably Well

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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. As with many other companies M.D.C. Holdings, Inc. (NYSE:MDC) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 M.D.C. Holdings

What Is M.D.C. Holdings’s Net Debt?

As you can see below, M.D.C. Holdings had US$1.67b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$474.4m in cash offsetting this, leading to net debt of about US$1.20b.

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NYSE:MDC Debt to Equity History July 25th 2022

How Strong Is M.D.C. Holdings’ Balance Sheet?

Zooming in on the latest balance sheet data, we can see that M.D.C. Holdings had liabilities of US$826.9m due within 12 months and liabilities of US$1.52b due beyond that. Offsetting this, it had US$474.4m in cash and US$114.8m in receivables that were due within 12 months. So its liabilities total US$1.76b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$2.65b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

M.D.C. Holdings has a low debt to EBITDA ratio of only 1.4. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there’s no doubt this company can take on debt while staying cool as a cucumber. On top of that, M.D.C. Holdings grew its EBIT by 51% over the last twelve months, and that growth will make it easier to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if M.D.C. Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, M.D.C. Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Both M.D.C. Holdings’s ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about M.D.C. Holdings’s use of debt. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should learn about the 3 warning signs we’ve spotted with M.D.C. Holdings (including 1 which is significant) .

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. 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.

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