We Think Melewar Industrial Group Berhad (KLSE:MELEWAR) Can Stay On Top Of Its Debt

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.' 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. We can see that Melewar Industrial Group Berhad (KLSE:MELEWAR) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Melewar Industrial Group Berhad

What Is Melewar Industrial Group Berhad's Debt?

As you can see below, at the end of December 2021, Melewar Industrial Group Berhad had RM118.3m of debt, up from RM88.0m a year ago. Click the image for more detail. However, it does have RM119.2m in cash offsetting this, leading to net cash of RM851.0k.

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

Zooming in on the latest balance sheet data, we can see that Melewar Industrial Group Berhad had liabilities of RM255.8m due within 12 months and liabilities of RM92.6m due beyond that. Offsetting this, it had RM119.2m in cash and RM81.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM147.9m.

This deficit is considerable relative to its market capitalization of RM161.7m, so it does suggest shareholders should keep an eye on Melewar Industrial Group Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Melewar Industrial Group Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Melewar Industrial Group Berhad grew its EBIT by 266% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Over the last three years, Melewar Industrial Group Berhad reported free cash flow worth 10% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

Although Melewar Industrial Group Berhad's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM851.0k. And we liked the look of last year's 266% year-on-year EBIT growth. So we don't have any problem with Melewar Industrial Group Berhad's use of debt. 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, and 1 of them makes us a bit uncomfortable.

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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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.