Stock Analysis

Is Malayan Cement Berhad (KLSE:MCEMENT) Using Too Much Debt?

KLSE:MCEMENT
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Malayan Cement Berhad (KLSE:MCEMENT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Malayan Cement Berhad

What Is Malayan Cement Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Malayan Cement Berhad had RM3.93b of debt, an increase on RM719.9m, over one year. However, it does have RM632.3m in cash offsetting this, leading to net debt of about RM3.30b.

debt-equity-history-analysis
KLSE:MCEMENT Debt to Equity History May 11th 2022

A Look At Malayan Cement Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Malayan Cement Berhad had liabilities of RM1.62b due within 12 months and liabilities of RM3.38b due beyond that. On the other hand, it had cash of RM632.3m and RM676.7m worth of receivables due within a year. So its liabilities total RM3.69b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of RM3.39b, we think shareholders really should watch Malayan Cement Berhad's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 12.6 hit our confidence in Malayan Cement Berhad like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Malayan Cement Berhad is that it turned last year's EBIT loss into a gain of RM96m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Malayan Cement 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Malayan Cement Berhad recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

To be frank both Malayan Cement Berhad's interest cover and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Malayan Cement Berhad stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For instance, we've identified 2 warning signs for Malayan Cement Berhad that you should be aware of.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Malayan Cement Berhad is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.