Here's Why MGB Berhad (KLSE:MGB) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, MGB Berhad (KLSE:MGB) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for MGB Berhad

How Much Debt Does MGB Berhad Carry?

As you can see below, MGB Berhad had RM137.5m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has RM19.5m in cash leading to net debt of about RM118.0m.

How Strong Is MGB Berhad's Balance Sheet?

We can see from the most recent balance sheet that MGB Berhad had liabilities of RM380.9m falling due within a year, and liabilities of RM54.2m due beyond that. Offsetting this, it had RM19.5m in cash and RM448.7m in receivables that were due within 12 months. So it actually has RM33.1m more liquid assets than total liabilities.

This surplus suggests that MGB Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MGB Berhad's debt is 4.3 times its EBITDA, and its EBIT cover its interest expense 2.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even more troubling is the fact that MGB Berhad actually let its EBIT decrease by 9.6% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MGB Berhad'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, MGB 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

Mulling over MGB Berhad's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Once we consider all the factors above, together, it seems to us that MGB Berhad's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Be aware that MGB Berhad is showing 1 warning sign in our investment analysis , 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. 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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