We Think Boustead Heavy Industries Corporation Berhad (KLSE:BHIC) Is Taking Some Risk With Its Debt

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.' 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. Importantly, Boustead Heavy Industries Corporation Berhad (KLSE:BHIC) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Boustead Heavy Industries Corporation Berhad

What Is Boustead Heavy Industries Corporation Berhad's Debt?

The chart below, which you can click on for greater detail, shows that Boustead Heavy Industries Corporation Berhad had RM291.3m in debt in September 2020; about the same as the year before. However, because it has a cash reserve of RM11.7m, its net debt is less, at about RM279.7m.

How Healthy Is Boustead Heavy Industries Corporation Berhad's Balance Sheet?

We can see from the most recent balance sheet that Boustead Heavy Industries Corporation Berhad had liabilities of RM264.4m falling due within a year, and liabilities of RM78.4m due beyond that. Offsetting these obligations, it had cash of RM11.7m as well as receivables valued at RM292.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM38.7m.

While this might seem like a lot, it is not so bad since Boustead Heavy Industries Corporation Berhad has a market capitalization of RM142.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Boustead Heavy Industries Corporation Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (8.6), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. This means we'd consider it to have a heavy debt load. However, the silver lining was that Boustead Heavy Industries Corporation Berhad achieved a positive EBIT of RM28m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is Boustead Heavy Industries Corporation 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, Boustead Heavy Industries Corporation Berhad's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Boustead Heavy Industries Corporation Berhad's interest cover and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Once we consider all the factors above, together, it seems to us that Boustead Heavy Industries Corporation Berhad's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. To that end, you should learn about the 2 warning signs we've spotted with Boustead Heavy Industries Corporation Berhad (including 1 which doesn't sit too well with us) .

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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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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