Does Melati Ehsan Holdings Berhad (KLSE:MELATI) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Melati Ehsan Holdings Berhad (KLSE:MELATI) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Melati Ehsan Holdings Berhad

What Is Melati Ehsan Holdings Berhad's Net Debt?

As you can see below, Melati Ehsan Holdings Berhad had RM72.7m of debt at November 2024, down from RM79.8m a year prior. However, it also had RM11.3m in cash, and so its net debt is RM61.4m.

How Healthy Is Melati Ehsan Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Melati Ehsan Holdings Berhad had liabilities of RM100.0m falling due within a year, and liabilities of RM55.0m due beyond that. On the other hand, it had cash of RM11.3m and RM97.1m worth of receivables due within a year. So it has liabilities totalling RM46.6m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM55.5m, so it does suggest shareholders should keep an eye on Melati Ehsan Holdings Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 10.4, it's fair to say Melati Ehsan Holdings Berhad does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 4.6 times, suggesting it can responsibly service its obligations. Shareholders should be aware that Melati Ehsan Holdings Berhad's EBIT was down 48% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Melati Ehsan Holdings Berhad 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Melati Ehsan Holdings Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Melati Ehsan Holdings Berhad's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its interest cover is not so bad. After considering the datapoints discussed, we think Melati Ehsan Holdings Berhad has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. We've identified 2 warning signs with Melati Ehsan Holdings Berhad (at least 1 which is significant) , and understanding them should be part of your investment process.

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.

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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.