Here's Why Minho (M) Berhad (KLSE:MINHO) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Minho (M) Berhad (KLSE:MINHO) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Minho (M) Berhad

What Is Minho (M) Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Minho (M) Berhad had RM21.0m of debt in September 2021, down from RM33.5m, one year before. But on the other hand it also has RM65.5m in cash, leading to a RM44.4m net cash position.

How Strong Is Minho (M) Berhad's Balance Sheet?

We can see from the most recent balance sheet that Minho (M) Berhad had liabilities of RM47.1m falling due within a year, and liabilities of RM19.5m due beyond that. Offsetting this, it had RM65.5m in cash and RM33.6m in receivables that were due within 12 months. So it actually has RM32.4m more liquid assets than total liabilities.

This excess liquidity suggests that Minho (M) Berhad is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Minho (M) Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The bad news is that Minho (M) Berhad saw its EBIT decline by 14% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Minho (M) 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 company can only pay off debt with cold hard cash, not accounting profits. Minho (M) 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, Minho (M) Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Minho (M) Berhad has net cash of RM44.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 332% of that EBIT to free cash flow, bringing in RM26m. So we are not troubled with Minho (M) Berhad's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Minho (M) Berhad (including 1 which is a bit unpleasant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.