EP Manufacturing Bhd (KLSE:EPMB) Has A Somewhat Strained Balance Sheet

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 EP Manufacturing Bhd (KLSE:EPMB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does EP Manufacturing Bhd Carry?

You can click the graphic below for the historical numbers, but it shows that EP Manufacturing Bhd had RM152.7m of debt in December 2024, down from RM187.7m, one year before. However, it also had RM93.4m in cash, and so its net debt is RM59.3m.

A Look At EP Manufacturing Bhd's Liabilities

The latest balance sheet data shows that EP Manufacturing Bhd had liabilities of RM254.2m due within a year, and liabilities of RM41.0m falling due after that. On the other hand, it had cash of RM93.4m and RM81.2m worth of receivables due within a year. So it has liabilities totalling RM120.6m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RM123.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

Check out our latest analysis for EP Manufacturing Bhd

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 1.1 times EBITDA, it is initially surprising to see that EP Manufacturing Bhd's EBIT has low interest coverage of 2.3 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that EP Manufacturing Bhd's EBIT was down 32% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since EP Manufacturing Bhd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, EP Manufacturing Bhd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both EP Manufacturing Bhd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. After considering the datapoints discussed, we think EP Manufacturing Bhd has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - EP Manufacturing Bhd has 2 warning signs we think 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.

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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.