Boilermech Holdings Berhad (KLSE:BOILERM) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Boilermech Holdings Berhad (KLSE:BOILERM) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Boilermech Holdings Berhad

How Much Debt Does Boilermech Holdings Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Boilermech Holdings Berhad had RM11.0m of debt, an increase on RM6.30m, over one year. However, it does have RM82.6m in cash offsetting this, leading to net cash of RM71.5m.

How Healthy Is Boilermech Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Boilermech Holdings Berhad had liabilities of RM111.4m falling due within a year, and liabilities of RM10.0m due beyond that. Offsetting this, it had RM82.6m in cash and RM112.7m in receivables that were due within 12 months. So it actually has RM73.8m more liquid assets than total liabilities.

This surplus suggests that Boilermech Holdings Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Boilermech Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Boilermech Holdings Berhad's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Boilermech Holdings Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Boilermech 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. Looking at the most recent three years, Boilermech Holdings Berhad recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Boilermech Holdings Berhad has net cash of RM71.5m, as well as more liquid assets than liabilities. So we don't have any problem with Boilermech Holdings Berhad's use of debt. 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. Take risks, for example - Boilermech Holdings 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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