These 4 Measures Indicate That MHC Plantations Bhd (KLSE:MHC) Is Using Debt Reasonably Well

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.' 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, MHC Plantations Bhd (KLSE:MHC) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for MHC Plantations Bhd

How Much Debt Does MHC Plantations Bhd Carry?

The image below, which you can click on for greater detail, shows that MHC Plantations Bhd had debt of RM126.9m at the end of September 2020, a reduction from RM141.2m over a year. However, it does have RM48.6m in cash offsetting this, leading to net debt of about RM78.3m.

A Look At MHC Plantations Bhd's Liabilities

The latest balance sheet data shows that MHC Plantations Bhd had liabilities of RM116.1m due within a year, and liabilities of RM97.8m falling due after that. Offsetting these obligations, it had cash of RM48.6m as well as receivables valued at RM25.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM139.4m.

This deficit is considerable relative to its market capitalization of RM158.2m, so it does suggest shareholders should keep an eye on MHC Plantations Bhd'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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

MHC Plantations Bhd's net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 4.6 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, MHC Plantations Bhd's EBIT launched higher than Elon Musk, gaining a whopping 208% on last year. 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 MHC Plantations Bhd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, MHC Plantations Bhd generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that MHC Plantations Bhd's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. All these things considered, it appears that MHC Plantations Bhd can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for MHC Plantations Bhd (of which 1 is a bit concerning!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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