These 4 Measures Indicate That Malaysia Steel Works (KL) Bhd (KLSE:MASTEEL) Is Using Debt Extensively

Warren Buffett famously said, '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. We note that Malaysia Steel Works (KL) Bhd. (KLSE:MASTEEL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Malaysia Steel Works (KL) Bhd

What Is Malaysia Steel Works (KL) Bhd's Net Debt?

As you can see below, Malaysia Steel Works (KL) Bhd had RM435.1m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has RM49.2m in cash leading to net debt of about RM385.8m.

How Strong Is Malaysia Steel Works (KL) Bhd's Balance Sheet?

According to the last reported balance sheet, Malaysia Steel Works (KL) Bhd had liabilities of RM779.6m due within 12 months, and liabilities of RM99.2m due beyond 12 months. Offsetting this, it had RM49.2m in cash and RM209.6m in receivables that were due within 12 months. So it has liabilities totalling RM620.0m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the RM212.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Malaysia Steel Works (KL) Bhd would probably need a major re-capitalization if its creditors were to demand repayment.

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

Malaysia Steel Works (KL) Bhd's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, the silver lining was that Malaysia Steel Works (KL) Bhd achieved a positive EBIT of RM67m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Malaysia Steel Works (KL) 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 company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Malaysia Steel Works (KL) Bhd's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Malaysia Steel Works (KL) Bhd's level of total liabilities was disappointing. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Overall, it seems to us that Malaysia Steel Works (KL) Bhd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Malaysia Steel Works (KL) Bhd that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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