Is Chin Hin Group Berhad (KLSE:CHINHIN) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Chin Hin Group Berhad (KLSE:CHINHIN) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Chin Hin Group Berhad had RM805.5m of debt, an increase on RM450.1m, over one year. However, it does have RM79.9m in cash offsetting this, leading to net debt of about RM725.5m.

How Healthy Is Chin Hin Group Berhad's Balance Sheet?

The latest balance sheet data shows that Chin Hin Group Berhad had liabilities of RM831.0m due within a year, and liabilities of RM317.9m falling due after that. Offsetting these obligations, it had cash of RM79.9m as well as receivables valued at RM614.6m due within 12 months. So its liabilities total RM454.4m more than the combination of its cash and short-term receivables.

Given Chin Hin Group Berhad has a market capitalization of RM3.10b, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.99 times and a disturbingly high net debt to EBITDA ratio of 14.9 hit our confidence in Chin Hin Group Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The silver lining is that Chin Hin Group Berhad grew its EBIT by 110% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. 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 Chin Hin Group 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Chin Hin Group Berhad burned a lot of cash. 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

Chin Hin Group Berhad's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Chin Hin Group Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Chin Hin Group Berhad is showing 4 warning signs in our investment analysis , and 1 of those is significant...

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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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.