Does Advancecon Holdings Berhad (KLSE:ADVCON) Have A Healthy Balance Sheet?

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.' 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?

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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Advancecon Holdings Berhad

How Much Debt Does Advancecon Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Advancecon Holdings Berhad had debt of RM80.1m, up from RM75.0m in one year. On the flip side, it has RM53.7m in cash leading to net debt of about RM26.5m.

How Healthy Is Advancecon Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Advancecon Holdings Berhad had liabilities of RM159.0m due within a year, and liabilities of RM61.4m falling due after that. Offsetting these obligations, it had cash of RM53.7m as well as receivables valued at RM188.0m due within 12 months. So it can boast RM21.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Advancecon Holdings Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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 0.70 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. Importantly, Advancecon Holdings Berhad's EBIT fell a jaw-dropping 51% in the last twelve months. 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 future earnings, more than anything, that will determine Advancecon Holdings Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Advancecon Holdings Berhad recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

We weren't impressed with Advancecon Holdings Berhad's interest cover, and its EBIT growth rate made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble managing its debt, based on its EBITDA,. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Advancecon Holdings Berhad (1 is a bit unpleasant) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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