Here's Why Menang Corporation (M) Berhad (KLSE:MENANG) Has A Meaningful Debt Burden

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Menang Corporation (M) Berhad (KLSE:MENANG) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Menang Corporation (M) Berhad

What Is Menang Corporation (M) Berhad's Debt?

The image below, which you can click on for greater detail, shows that Menang Corporation (M) Berhad had debt of RM355.9m at the end of June 2023, a reduction from RM418.6m over a year. However, it also had RM58.1m in cash, and so its net debt is RM297.8m.

How Healthy Is Menang Corporation (M) Berhad's Balance Sheet?

The latest balance sheet data shows that Menang Corporation (M) Berhad had liabilities of RM142.7m due within a year, and liabilities of RM362.5m falling due after that. On the other hand, it had cash of RM58.1m and RM70.6m worth of receivables due within a year. So it has liabilities totalling RM376.5m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM433.4m, so it does suggest shareholders should keep an eye on Menang Corporation (M) Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 5.1 hit our confidence in Menang Corporation (M) Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Notably, Menang Corporation (M) Berhad's EBIT was pretty flat over the last year, which isn't ideal given the debt load. 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 Menang Corporation (M) Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Menang Corporation (M) Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Menang Corporation (M) Berhad's net debt to EBITDA and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Menang Corporation (M) Berhad's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 Menang Corporation (M) Berhad has 3 warning signs (and 1 which is significant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.