Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, EP Manufacturing Bhd (KLSE:EPMB) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
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What Is EP Manufacturing Bhd's Debt?
You can click the graphic below for the historical numbers, but it shows that EP Manufacturing Bhd had RM164.3m of debt in March 2024, down from RM183.4m, one year before. However, because it has a cash reserve of RM56.2m, its net debt is less, at about RM108.1m.
A Look At EP Manufacturing Bhd's Liabilities
Zooming in on the latest balance sheet data, we can see that EP Manufacturing Bhd had liabilities of RM225.4m due within 12 months and liabilities of RM45.5m due beyond that. Offsetting this, it had RM56.2m in cash and RM91.6m in receivables that were due within 12 months. So its liabilities total RM123.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of RM137.7m, so it does suggest shareholders should keep an eye on EP Manufacturing Bhd's use of debt. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
EP Manufacturing Bhd has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.8 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Pleasingly, EP Manufacturing Bhd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 368% gain in the last twelve months. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, EP Manufacturing Bhd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
EP Manufacturing Bhd's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that EP Manufacturing Bhd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for EP Manufacturing Bhd that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
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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.
Solid track record with adequate balance sheet.