Here's Why New Hoong Fatt Holdings Berhad (KLSE:NHFATT) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, New Hoong Fatt Holdings Berhad (KLSE:NHFATT) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

Check out our latest analysis for New Hoong Fatt Holdings Berhad

How Much Debt Does New Hoong Fatt Holdings Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that New Hoong Fatt Holdings Berhad had RM23.4m of debt in December 2020, down from RM38.3m, one year before. But on the other hand it also has RM30.9m in cash, leading to a RM7.43m net cash position.

How Healthy Is New Hoong Fatt Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that New Hoong Fatt Holdings Berhad had liabilities of RM48.2m falling due within a year, and liabilities of RM41.9m due beyond that. Offsetting these obligations, it had cash of RM30.9m as well as receivables valued at RM54.7m due within 12 months. So its liabilities total RM4.61m more than the combination of its cash and short-term receivables.

Given New Hoong Fatt Holdings Berhad has a market capitalization of RM181.1m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, New Hoong Fatt Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for New Hoong Fatt Holdings Berhad if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is New Hoong Fatt Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. New Hoong Fatt Holdings Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, New Hoong Fatt Holdings Berhad actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

We could understand if investors are concerned about New Hoong Fatt Holdings Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM7.43m. The cherry on top was that in converted 119% of that EBIT to free cash flow, bringing in RM33m. So we are not troubled with New Hoong Fatt Holdings Berhad's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that New Hoong Fatt Holdings Berhad is showing 3 warning signs in our investment analysis , and 1 of those 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. 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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