Stock Analysis

Here's Why Melewar Industrial Group Berhad (KLSE:MELEWAR) Has A Meaningful Debt Burden

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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Melewar Industrial Group Berhad (KLSE:MELEWAR) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Melewar Industrial Group Berhad

How Much Debt Does Melewar Industrial Group Berhad Carry?

As you can see below, at the end of September 2021, Melewar Industrial Group Berhad had RM180.3m of debt, up from RM80.1m a year ago. Click the image for more detail. On the flip side, it has RM89.0m in cash leading to net debt of about RM91.3m.

KLSE:MELEWAR Debt to Equity History January 13th 2022

How Healthy Is Melewar Industrial Group Berhad's Balance Sheet?

The latest balance sheet data shows that Melewar Industrial Group Berhad had liabilities of RM313.9m due within a year, and liabilities of RM87.0m falling due after that. Offsetting this, it had RM89.0m in cash and RM97.7m in receivables that were due within 12 months. So it has liabilities totalling RM214.3m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's RM143.8m market capitalization, you might well be inclined to review the balance sheet intently. 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Melewar Industrial Group Berhad has a low net debt to EBITDA ratio of only 0.97. And its EBIT easily covers its interest expense, being 38.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Melewar Industrial Group Berhad grew its EBIT by 3,174% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Melewar Industrial Group Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Melewar Industrial Group Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Melewar Industrial Group Berhad's level of total liabilities and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its interest cover 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 Melewar Industrial Group Berhad stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Melewar Industrial Group Berhad (1 is a bit concerning!) that you should be aware of before investing here.

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.

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