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EP Manufacturing Bhd (KLSE:EPMB) Has A Somewhat Strained Balance Sheet
Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies EP Manufacturing Bhd (KLSE:EPMB) 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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for EP Manufacturing Bhd
What Is EP Manufacturing Bhd's Debt?
As you can see below, EP Manufacturing Bhd had RM185.0m of debt at March 2021, down from RM195.6m a year prior. On the flip side, it has RM25.4m in cash leading to net debt of about RM159.6m.
How Strong Is EP Manufacturing Bhd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that EP Manufacturing Bhd had liabilities of RM243.3m due within 12 months and liabilities of RM31.6m due beyond that. Offsetting this, it had RM25.4m in cash and RM71.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM178.4m.
This deficit casts a shadow over the RM96.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, EP Manufacturing Bhd would likely require a major re-capitalisation if it had to pay its creditors today.
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.
While EP Manufacturing Bhd's debt to EBITDA ratio (4.6) suggests that it uses some debt, its interest cover is very weak, at 0.011, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, the silver lining was that EP Manufacturing Bhd achieved a positive EBIT of RM93k in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is EP Manufacturing Bhd'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, EP Manufacturing Bhd actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
On the face of it, EP Manufacturing Bhd's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that EP Manufacturing Bhd has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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 example, we've discovered 4 warning signs for EP Manufacturing Bhd (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
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.
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Access Free AnalysisThis 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.
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About KLSE:EPMB
EP Manufacturing Bhd
An investment holding company, engages in the manufacture, distribution, and sale of automotive parts and components in Malaysia and Saudi Arabia.
Adequate balance sheet and fair value.
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