CB Industrial Product Holding Berhad (KLSE:CBIP) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies CB Industrial Product Holding Berhad (KLSE:CBIP) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for CB Industrial Product Holding Berhad

What Is CB Industrial Product Holding Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 CB Industrial Product Holding Berhad had RM179.2m of debt, an increase on RM156.7m, over one year. On the flip side, it has RM151.7m in cash leading to net debt of about RM27.5m.

How Healthy Is CB Industrial Product Holding Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CB Industrial Product Holding Berhad had liabilities of RM216.7m due within 12 months and liabilities of RM127.1m due beyond that. Offsetting these obligations, it had cash of RM151.7m as well as receivables valued at RM336.1m due within 12 months. So it actually has RM144.0m more liquid assets than total liabilities.

This excess liquidity suggests that CB Industrial Product Holding Berhad is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CB Industrial Product Holding Berhad has a low net debt to EBITDA ratio of only 0.41. And its EBIT easily covers its interest expense, being 22.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that CB Industrial Product Holding Berhad grew its EBIT by 151% over twelve months. That boost will make it even easier to pay down debt going forward. 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 CB Industrial Product Holding Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, CB Industrial Product Holding Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

CB Industrial Product Holding Berhad's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Zooming out, CB Industrial Product Holding Berhad seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for CB Industrial Product Holding Berhad that you should be aware of.

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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