These 4 Measures Indicate That Eversafe Rubber Berhad (KLSE:ESAFE) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Eversafe Rubber Berhad (KLSE:ESAFE) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Eversafe Rubber Berhad

What Is Eversafe Rubber Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Eversafe Rubber Berhad had debt of RM41.7m at the end of December 2023, a reduction from RM53.8m over a year. However, it also had RM22.7m in cash, and so its net debt is RM19.0m.

How Healthy Is Eversafe Rubber Berhad's Balance Sheet?

The latest balance sheet data shows that Eversafe Rubber Berhad had liabilities of RM48.5m due within a year, and liabilities of RM21.5m falling due after that. On the other hand, it had cash of RM22.7m and RM41.4m worth of receivables due within a year. So its liabilities total RM5.96m more than the combination of its cash and short-term receivables.

Of course, Eversafe Rubber Berhad has a market capitalization of RM52.9m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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 Eversafe Rubber Berhad has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 1.8. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. Notably, Eversafe Rubber Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM4.8m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Eversafe Rubber Berhad'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's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Eversafe Rubber Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Eversafe Rubber Berhad's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But the stark truth is that we are concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Eversafe Rubber Berhad can handle its debt fairly comfortably. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Eversafe Rubber Berhad you should be aware of, and 1 of them is a bit concerning.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.