Is My E.G. Services Berhad (KLSE:MYEG) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies My E.G. Services Berhad (KLSE:MYEG) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for My E.G. Services Berhad

How Much Debt Does My E.G. Services Berhad Carry?

As you can see below, at the end of June 2022, My E.G. Services Berhad had RM241.1m of debt, up from RM151.9m a year ago. Click the image for more detail. However, it does have RM223.3m in cash offsetting this, leading to net debt of about RM17.8m.

How Strong Is My E.G. Services Berhad's Balance Sheet?

According to the last reported balance sheet, My E.G. Services Berhad had liabilities of RM300.0m due within 12 months, and liabilities of RM145.2m due beyond 12 months. Offsetting these obligations, it had cash of RM223.3m as well as receivables valued at RM621.3m due within 12 months. So it actually has RM399.4m more liquid assets than total liabilities.

This short term liquidity is a sign that My E.G. Services Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, My E.G. Services Berhad has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

With debt at a measly 0.049 times EBITDA and EBIT covering interest a whopping 56.9 times, it's clear that My E.G. Services Berhad is not a desperate borrower. So relative to past earnings, the debt load seems trivial. And we also note warmly that My E.G. Services Berhad grew its EBIT by 10% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine My E.G. Services Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, My E.G. Services Berhad actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Happily, My E.G. Services Berhad's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that My E.G. Services Berhad can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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, we've discovered 1 warning sign for My E.G. Services Berhad that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.