The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that SMIS Corporation Berhad (KLSE:SMISCOR) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does SMIS Corporation Berhad Carry?
The image below, which you can click on for greater detail, shows that SMIS Corporation Berhad had debt of RM13.5m at the end of December 2020, a reduction from RM14.4m over a year. But on the other hand it also has RM17.0m in cash, leading to a RM3.57m net cash position.
How Strong Is SMIS Corporation Berhad's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that SMIS Corporation Berhad had liabilities of RM38.8m due within 12 months and liabilities of RM5.53m due beyond that. Offsetting these obligations, it had cash of RM17.0m as well as receivables valued at RM28.2m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This short term liquidity is a sign that SMIS Corporation Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, SMIS Corporation Berhad boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SMIS Corporation Berhad 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.
In the last year SMIS Corporation Berhad had a loss before interest and tax, and actually shrunk its revenue by 19%, to RM101m. We would much prefer see growth.
So How Risky Is SMIS Corporation Berhad?
While SMIS Corporation Berhad lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow RM5.6m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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. For example - SMIS Corporation Berhad 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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