Mestron Holdings Berhad (KLSE:MESTRON) Has A Pretty Healthy Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Mestron Holdings Berhad (KLSE:MESTRON) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Mestron Holdings Berhad

What Is Mestron Holdings Berhad's Debt?

As you can see below, Mestron Holdings Berhad had RM7.77m of debt at December 2020, down from RM8.78m a year prior. But it also has RM18.5m in cash to offset that, meaning it has RM10.7m net cash.

A Look At Mestron Holdings Berhad's Liabilities

We can see from the most recent balance sheet that Mestron Holdings Berhad had liabilities of RM13.0m falling due within a year, and liabilities of RM8.81m due beyond that. Offsetting this, it had RM18.5m in cash and RM22.5m in receivables that were due within 12 months. So it can boast RM19.3m more liquid assets than total liabilities.

This surplus suggests that Mestron Holdings Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Mestron Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Mestron Holdings Berhad grew its EBIT by 280% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Mestron Holdings 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Mestron Holdings 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. In the last three years, Mestron Holdings Berhad created free cash flow amounting to 6.7% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Mestron Holdings Berhad has RM10.7m in net cash and a decent-looking balance sheet. And we liked the look of last year's 280% year-on-year EBIT growth. So is Mestron Holdings Berhad's debt a risk? It doesn't seem so to us. 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 - Mestron Holdings Berhad has 3 warning signs we think 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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This article by Simply Wall St is general in nature. 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.
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