Advancecon Holdings Berhad (KLSE:ADVCON) Has A Pretty Healthy Balance Sheet

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 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, Advancecon Holdings Berhad (KLSE:ADVCON) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Advancecon Holdings Berhad

What Is Advancecon Holdings Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Advancecon Holdings Berhad had RM79.5m of debt, an increase on RM63.7m, over one year. However, it also had RM54.9m in cash, and so its net debt is RM24.5m.

A Look At Advancecon Holdings Berhad's Liabilities

The latest balance sheet data shows that Advancecon Holdings Berhad had liabilities of RM146.8m due within a year, and liabilities of RM65.8m falling due after that. Offsetting these obligations, it had cash of RM54.9m as well as receivables valued at RM175.8m due within 12 months. So it actually has RM18.0m more liquid assets than total liabilities.

This surplus suggests that Advancecon Holdings Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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).

Given net debt is only 0.90 times EBITDA, it is initially surprising to see that Advancecon Holdings Berhad's EBIT has low interest coverage of 1.8 times. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Advancecon Holdings Berhad's EBIT was down 30% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Advancecon 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Advancecon Holdings Berhad produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Advancecon Holdings Berhad's EBIT growth rate was a real negative on this analysis, as was its interest cover. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Advancecon Holdings Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 Advancecon Holdings Berhad is showing 5 warning signs in our investment analysis , and 2 of those are significant...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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