Is Menang Corporation (M) Berhad (KLSE:MENANG) A Risky Investment?

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. As with many other companies Menang Corporation (M) Berhad (KLSE:MENANG) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Menang Corporation (M) Berhad

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

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Menang Corporation (M) Berhad had RM529.4m of debt, an increase on RM20.2m, over one year. However, because it has a cash reserve of RM43.9m, its net debt is less, at about RM485.5m.

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

Zooming in on the latest balance sheet data, we can see that Menang Corporation (M) Berhad had liabilities of RM132.0m due within 12 months and liabilities of RM544.9m due beyond that. On the other hand, it had cash of RM43.9m and RM75.1m worth of receivables due within a year. So its liabilities total RM558.0m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM182.7m 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Menang Corporation (M) Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (22.3), and fairly weak interest coverage, since EBIT is just 0.97 times the interest expense. The debt burden here is substantial. Worse, Menang Corporation (M) Berhad's EBIT was down 72% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Menang Corporation (M) Berhad actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. 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. 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 4 warning signs (and 2 which can't be ignored) 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. 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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