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. Importantly, Mexan Limited (HKG:22) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Mexan
How Much Debt Does Mexan Carry?
As you can see below, at the end of March 2021, Mexan had HK$61.7m of debt, up from HK$30.5m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$27.8m, its net debt is less, at about HK$33.9m.
How Healthy Is Mexan's Balance Sheet?
We can see from the most recent balance sheet that Mexan had liabilities of HK$77.5m falling due within a year, and liabilities of HK$12.7m due beyond that. On the other hand, it had cash of HK$27.8m and HK$385.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$62.1m.
Mexan has a market capitalization of HK$230.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mexan will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Mexan had a loss before interest and tax, and actually shrunk its revenue by 44%, to HK$24m. To be frank that doesn't bode well.
Caveat Emptor
Not only did Mexan's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$37m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$12m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Mexan has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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.
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About SEHK:22
Mexan
An investment holding company, supplies building materials and furniture in Hong Kong and Macau.
Adequate balance sheet and overvalued.
