David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies My EG Services Berhad (KLSE: MYEG) uses debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
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What is My EG Services Berhad’s debt?
As you can see below, at the end of June 2022, My EG Services Berhad had a debt of RM241.1 million, compared to RM151.9 million a year ago. Click on the image for more details. However, he has RM223.3 million in cash to offset this, resulting in a net debt of around RM17.8 million.
How strong is My EG Services Berhad’s balance sheet?
According to the latest published balance sheet, My EG Services Berhad had liabilities of RM300.0 million due within 12 months and liabilities of RM145.2 million due beyond 12 months. As compensation for these obligations, it had cash of RM223.3 million and receivables valued at RM621.3 million due within 12 months. So he actually has RM399.4 million After liquid assets than total liabilities.
This short-term liquidity is a sign that My EG Services Berhad could probably repay its debt easily, as its balance sheet is far from stretched. Carrying virtually no net debt, My EG Services Berhad indeed has very little debt.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
With debt at a meager 0.049 times EBITDA and EBIT covering 56.9 times interest, it is clear that My EG Services Berhad is not a desperate borrower. Thus, compared to past earnings, the level of debt seems insignificant. And we also warmly note that My EG Services Berhad increased its EBIT by 10% last year, which makes it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine My EG Services Berhad’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, My EG Services Berhad has actually had a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.
Our point of view
Fortunately, My EG Services Berhad’s impressive interest coverage means it has the upper hand on its debt. But the harsh truth is that we are concerned about its conversion from EBIT to free cash flow. Looking at all of the above factors together, it seems to us that My EG Services Berhad can manage its debt quite comfortably. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 1 warning sign for My EG Services Berhad which you should be aware of before investing here.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
Valuation is complex, but we help make it simple.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.