Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies M K Land Holdings Berhad (KLSE:MKLAND) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does M K Land Holdings Berhad Carry?
As you can see below, M K Land Holdings Berhad had RM23.0m of debt at March 2022, down from RM32.3m a year prior. But on the other hand it also has RM75.2m in cash, leading to a RM52.2m net cash position.
How Strong Is M K Land Holdings Berhad's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that M K Land Holdings Berhad had liabilities of RM337.3m due within 12 months and liabilities of RM84.7m due beyond that. Offsetting these obligations, it had cash of RM75.2m as well as receivables valued at RM76.1m due within 12 months. So it has liabilities totalling RM270.7m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's RM186.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. M K Land Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
It is well worth noting that M K Land Holdings Berhad's EBIT shot up like bamboo after rain, gaining 53% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since M K Land Holdings 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 company can only pay off debt with cold hard cash, not accounting profits. M K Land Holdings 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, M K Land Holdings Berhad actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although M K Land Holdings 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 RM52.2m. The cherry on top was that in converted 188% of that EBIT to free cash flow, bringing in RM20m. So we are not troubled with M K Land Holdings Berhad's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with M K Land Holdings Berhad (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.
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. 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.
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