Is Nova MSC Berhad (KLSE:NOVAMSC) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Nova MSC Berhad (KLSE:NOVAMSC) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Nova MSC Berhad

What Is Nova MSC Berhad's Debt?

As you can see below, Nova MSC Berhad had RM6.99m of debt at September 2020, down from RM8.90m a year prior. But it also has RM15.5m in cash to offset that, meaning it has RM8.53m net cash.

How Healthy Is Nova MSC Berhad's Balance Sheet?

According to the last reported balance sheet, Nova MSC Berhad had liabilities of RM16.4m due within 12 months, and liabilities of RM459.0k due beyond 12 months. Offsetting these obligations, it had cash of RM15.5m as well as receivables valued at RM43.0m due within 12 months. So it can boast RM41.6m more liquid assets than total liabilities.

This surplus strongly suggests that Nova MSC Berhad has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Nova MSC Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Nova MSC Berhad's EBIT was down 64% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nova MSC 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Nova MSC 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. During the last three years, Nova MSC Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Nova MSC Berhad has RM8.53m in net cash and a decent-looking balance sheet. So while Nova MSC Berhad does not have a great balance sheet, it's certainly not too bad. 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, we've discovered 2 warning signs for Nova MSC Berhad that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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