Master-Pack Group Berhad (KLSE:MASTER) Seems To Use Debt Rather Sparingly

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. Importantly, Master-Pack Group Berhad (KLSE:MASTER) does carry debt. 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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Master-Pack Group Berhad

What Is Master-Pack Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that Master-Pack Group Berhad had debt of RM8.33m at the end of March 2021, a reduction from RM11.0m over a year. But on the other hand it also has RM35.7m in cash, leading to a RM27.3m net cash position.

A Look At Master-Pack Group Berhad's Liabilities

According to the last reported balance sheet, Master-Pack Group Berhad had liabilities of RM19.1m due within 12 months, and liabilities of RM6.36m due beyond 12 months. Offsetting these obligations, it had cash of RM35.7m as well as receivables valued at RM27.3m due within 12 months. So it can boast RM37.5m more liquid assets than total liabilities.

This surplus strongly suggests that Master-Pack Group Berhad has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Master-Pack Group Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Master-Pack Group Berhad's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is Master-Pack Group Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Master-Pack Group Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Master-Pack Group Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Master-Pack Group Berhad has RM27.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in RM12m. So we don't think Master-Pack Group Berhad's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Master-Pack Group Berhad you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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