Is MCT Berhad (KLSE:MCT) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, MCT Berhad (KLSE:MCT) does carry debt. But is this debt a concern to shareholders?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for MCT Berhad

How Much Debt Does MCT Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that MCT Berhad had RM31.3m of debt in September 2020, down from RM526.2m, one year before. But on the other hand it also has RM538.7m in cash, leading to a RM507.4m net cash position.

How Healthy Is MCT Berhad's Balance Sheet?

The latest balance sheet data shows that MCT Berhad had liabilities of RM539.1m due within a year, and liabilities of RM550.5m falling due after that. Offsetting this, it had RM538.7m in cash and RM296.6m in receivables that were due within 12 months. So its liabilities total RM254.3m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of RM276.8m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, MCT Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that MCT Berhad's EBIT was down 51% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is MCT Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MCT Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, MCT Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While MCT Berhad does have more liabilities than liquid assets, it also has net cash of RM507.4m. The cherry on top was that in converted 141% of that EBIT to free cash flow, bringing in RM118m. So while MCT Berhad does not have a great balance sheet, it's certainly not too bad. 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. Be aware that MCT Berhad is showing 4 warning signs in our investment analysis , and 1 of those is significant...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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