Does Mesnac (SZSE:002073) Have A Healthy Balance Sheet?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Mesnac Co., Ltd. (SZSE:002073) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Mesnac's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Mesnac had CN¥1.61b of debt, an increase on CN¥1.53b, over one year. But it also has CN¥3.84b in cash to offset that, meaning it has CN¥2.23b net cash.

How Strong Is Mesnac's Balance Sheet?

We can see from the most recent balance sheet that Mesnac had liabilities of CN¥10.0b falling due within a year, and liabilities of CN¥1.31b due beyond that. Offsetting these obligations, it had cash of CN¥3.84b as well as receivables valued at CN¥2.10b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.40b.

While this might seem like a lot, it is not so bad since Mesnac has a market capitalization of CN¥9.63b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Mesnac boasts net cash, so it's fair to say it does not have a heavy debt load!

See our latest analysis for Mesnac

In addition to that, we're happy to report that Mesnac has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Mesnac's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Mesnac has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Mesnac saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

Although Mesnac's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.23b. And it impressed us with its EBIT growth of 56% over the last year. So we are not troubled with Mesnac's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Mesnac you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.