Does Menang Corporation (M) Berhad (KLSE:MENANG) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Menang Corporation (M) Berhad (KLSE:MENANG) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Menang Corporation (M) Berhad

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

As you can see below, at the end of September 2020, Menang Corporation (M) Berhad had RM369.7m of debt, up from RM20.2m a year ago. Click the image for more detail. However, it also had RM43.2m in cash, and so its net debt is RM326.5m.

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

According to the last reported balance sheet, Menang Corporation (M) Berhad had liabilities of RM385.8m due within 12 months, and liabilities of RM340.1m due beyond 12 months. On the other hand, it had cash of RM43.2m and RM53.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM629.2m.

The deficiency here weighs heavily on the RM252.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Menang Corporation (M) Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

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 0.96 times and a disturbingly high net debt to EBITDA ratio of 12.7 hit our confidence in Menang Corporation (M) Berhad like a one-two punch to the gut. The debt burden here is substantial. Even worse, Menang Corporation (M) Berhad saw its EBIT tank 23% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Menang Corporation (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. 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

To be frank both Menang Corporation (M) Berhad's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. After considering the datapoints discussed, we think Menang Corporation (M) Berhad has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 which are a bit unpleasant) we think you should know about.

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. 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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