David Iben put it right when he said, “Volatility is not a risk we care about. What we care about is avoiding permanent capital loss. It is only natural to consider a company’s balance sheet when examining how risky it is, as debt often occurs when a company collapses. We note that Malaysia Smelting Corporation Berhad KLSE: MSC) does have debts on the balance sheet. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to pay off its lenders, it is at their mercy. When things get really bad, the lenders can take control of the business. A more frequent (but still costly) occurrence, however, is that a company has to issue shares at bargain prices, permanently diluting shareholders just to keep its balance sheet up. Of course, many companies use debt to finance growth without negative consequences. The first step in considering a company’s debt levels is to consider the cash and debt together.
What is Malaysia Smelting Corporation Berhad’s net debt?
As you can see below, Malaysia Smelting Corporation Berhad had a debt of RM478.0 million at the end of December 2020, up from RM339.6 million a year ago. Click on the image for more details. However, it also had RM36.8 million in cash, and so its net debt is RM441.2 million.
How healthy is the balance sheet of Malaysia Smelting Corporation Berhad?
We can see from the most recent balance sheet that Malaysia Smelting Corporation Berhad had liabilities of RM430.6 million within one year and liabilities of RM166.6 million beyond that. To offset these commitments, it had cash of RM36.8 million and receivables of RM44.3 million due within 12 months. So his liabilities outweigh the sum of his cash and (short term) receivables by RM516.0 million.
Malaysia Smelting Corporation Berhad has a market capitalization of RM1.12 billion, so it could very likely attract cash to improve its balance sheet should the need arise. However, it still pays to take a close look at his ability to pay off debt.
We measure a company’s indebtedness in relation to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and by calculating how convenient its earnings before interest and taxes (EBIT) are interest cover. costs (interest coverage). We therefore consider debt in relation to profit, both with and without depreciation and amortization costs.
Malaysia Smelting Corporation Berhad has a fairly high debt / EBITDA ratio of 6.8, indicating significant indebtedness. However, the interest coverage of 2.8 is quite strong, which is a good sign. Worse, Malaysia Smelting Corporation Berhad saw its EBIT tank 41% in the last 12 months. If revenues continue to follow that trajectory, paying off that debt burden will be more difficult than convincing us to run a marathon in the rain. There is no doubt that we learn most about debt from the balance sheet. But you cannot see debt in total isolation; as Malaysia Smelting Corporation Berhad needs income to pay off that debt. So if you want to know more about the earnings it might be worth checking it out this graph of its long-term profit development
Finally, a company needs free cash flow to pay off debts; accounting profits just don’t cut it. So we always look at how much of that EBIT is translated into free cash flow. Considering the past three years, Malaysia Smelting Corporation Berhad has generally recorded a cash outflow. Debt is usually more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders must hope for improvement.
To be fair, both Malaysia Smelting Corporation Berhad’s net debt to EBITDA and its track record of (non) growing EBIT make us quite uncomfortable with its debt levels. But the level of total liabilities is certainly not that bad. All in all, it seems to us that Malaysia Smelting Corporation Berhad’s balance sheet really does pose a significant risk to the company. For this reason, we are quite careful with the stock, and we think shareholders should keep a close eye on its liquidity. Clearly, balance sheet is the area to focus on when analyzing debt. However, not all investment risks are in the balance sheet – far from it. Example: we have seen it 3 warning signs for Malaysia Smelting Corporation Berhad you have to be aware of it, and one of them makes us a little uncomfortable.
At the end of the day, it is often better to focus on companies that are free of net debt. You have access to our special list of such companies (all with a track record of earnings growth). It is free.
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This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell stock and does not take into account your objectives or your financial situation. We strive to provide you with long-term focused analysis powered by fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality material. Simply Wall St has no exposure to said stocks.
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