Does Chin Hin Group Berhad (KLSE:CHINHIN) Have A 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.' 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. Importantly, Chin Hin Group Berhad (KLSE:CHINHIN) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Chin Hin Group Berhad

What Is Chin Hin Group Berhad's Debt?

As you can see below, at the end of September 2022, Chin Hin Group Berhad had RM938.3m of debt, up from RM522.1m a year ago. Click the image for more detail. However, because it has a cash reserve of RM98.3m, its net debt is less, at about RM840.0m.

A Look At Chin Hin Group Berhad's Liabilities

According to the last reported balance sheet, Chin Hin Group Berhad had liabilities of RM911.4m due within 12 months, and liabilities of RM460.7m due beyond 12 months. Offsetting this, it had RM98.3m in cash and RM631.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM642.1m.

Given Chin Hin Group Berhad has a market capitalization of RM6.39b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chin Hin Group Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (11.6), and fairly weak interest coverage, since EBIT is just 1.6 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Chin Hin Group Berhad actually grew its EBIT by a hefty 134%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chin Hin Group Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Chin Hin Group Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Chin Hin Group Berhad's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Chin Hin Group Berhad's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 3 warning signs with Chin Hin Group Berhad , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.