Is MCT Berhad (KLSE:MCT) Using Too Much 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.' 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. We note that MCT Berhad (KLSE:MCT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for MCT Berhad

What Is MCT Berhad's Debt?

As you can see below, at the end of December 2020, MCT Berhad had RM562.0m of debt, up from RM526.2m a year ago. Click the image for more detail. However, it does have RM599.3m in cash offsetting this, leading to net cash of RM37.3m.

How Healthy Is MCT Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that MCT Berhad had liabilities of RM524.8m due within 12 months and liabilities of RM542.0m due beyond that. On the other hand, it had cash of RM599.3m and RM209.8m worth of receivables due within a year. So it has liabilities totalling RM257.7m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM357.0m, so it does suggest shareholders should keep an eye on MCT Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, MCT Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, MCT Berhad grew its EBIT by 80% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. MCT 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. 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

Although MCT 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 RM37.3m. The cherry on top was that in converted 210% of that EBIT to free cash flow, bringing in RM147m. So we don't have any problem with MCT Berhad's use of debt. 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. Case in point: We've spotted 5 warning signs for MCT Berhad you should be aware of, and 2 of them are potentially serious.

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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