Stock Analysis

Melewar Industrial Group Berhad (KLSE:MELEWAR) Seems To Use Debt Quite Sensibly

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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 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. As with many other companies Melewar Industrial Group Berhad (KLSE:MELEWAR) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Melewar Industrial Group Berhad

What Is Melewar Industrial Group Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Melewar Industrial Group Berhad had RM92.7m of debt in March 2021, down from RM130.3m, one year before. However, it does have RM154.2m in cash offsetting this, leading to net cash of RM61.5m.

KLSE:MELEWAR Debt to Equity History August 27th 2021

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

The latest balance sheet data shows that Melewar Industrial Group Berhad had liabilities of RM244.1m due within a year, and liabilities of RM86.5m falling due after that. Offsetting this, it had RM154.2m in cash and RM105.9m in receivables that were due within 12 months. So it has liabilities totalling RM70.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Melewar Industrial Group Berhad has a market capitalization of RM206.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Melewar Industrial Group Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Melewar Industrial Group Berhad has increased its EBIT by 2.6% over twelve months, which should ease any concerns about debt repayment. 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 Melewar Industrial Group Berhad will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Melewar Industrial Group Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last two years, Melewar Industrial Group Berhad generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While Melewar Industrial Group Berhad does have more liabilities than liquid assets, it also has net cash of RM61.5m. And it impressed us with free cash flow of RM111m, being 81% of its EBIT. So we don't think Melewar Industrial Group Berhad's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for Melewar Industrial Group Berhad you should be aware of.

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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