These 4 Measures Indicate That SKB Shutters Corporation Berhad (KLSE:SKBSHUT) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that SKB Shutters Corporation Berhad (KLSE:SKBSHUT) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SKB Shutters Corporation Berhad

What Is SKB Shutters Corporation Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 SKB Shutters Corporation Berhad had debt of RM80.1m, up from RM48.9m in one year. On the flip side, it has RM36.4m in cash leading to net debt of about RM43.7m.

A Look At SKB Shutters Corporation Berhad's Liabilities

We can see from the most recent balance sheet that SKB Shutters Corporation Berhad had liabilities of RM56.0m falling due within a year, and liabilities of RM62.6m due beyond that. On the other hand, it had cash of RM36.4m and RM23.4m worth of receivables due within a year. So it has liabilities totalling RM58.9m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RM80.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

SKB Shutters Corporation Berhad's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its commanding EBIT of 12.4 times its interest expense, implies the debt load is as light as a peacock feather. If SKB Shutters Corporation Berhad can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is SKB Shutters Corporation Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, SKB Shutters Corporation Berhad recorded free cash flow worth 67% 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.

Our View

Happily, SKB Shutters Corporation Berhad's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. All these things considered, it appears that SKB Shutters Corporation Berhad can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for SKB Shutters Corporation Berhad that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.