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 Malaysian Pacific Industries Berhad (KLSE:MPI) does use debt in its business. But the real question is whether this debt is making the company risky.
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. 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.
What Is Malaysian Pacific Industries Berhad's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2021 Malaysian Pacific Industries Berhad had debt of RM82.9m, up from RM14.5m in one year. However, it does have RM1.01b in cash offsetting this, leading to net cash of RM927.1m.
How Strong Is Malaysian Pacific Industries Berhad's Balance Sheet?
According to the last reported balance sheet, Malaysian Pacific Industries Berhad had liabilities of RM565.4m due within 12 months, and liabilities of RM25.0m due beyond 12 months. Offsetting this, it had RM1.01b in cash and RM319.9m in receivables that were due within 12 months. So it can boast RM739.5m more liquid assets than total liabilities.
This short term liquidity is a sign that Malaysian Pacific Industries Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Malaysian Pacific Industries Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Malaysian Pacific Industries Berhad grew its EBIT by 83% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Malaysian Pacific Industries Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Malaysian Pacific Industries 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. Over the most recent three years, Malaysian Pacific Industries Berhad recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Malaysian Pacific Industries Berhad has net cash of RM927.1m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 83% over the last year. So we don't think Malaysian Pacific Industries Berhad's use of debt is risky. 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. We've identified 1 warning sign with Malaysian Pacific Industries Berhad , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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