Is Chin Hin Group Berhad (KLSE:CHINHIN) Using Too Much Debt?

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 should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Chin Hin Group Berhad

What Is Chin Hin Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Chin Hin Group Berhad had debt of RM945.2m, up from RM888.4m in one year. However, because it has a cash reserve of RM163.0m, its net debt is less, at about RM782.2m.

A Look At Chin Hin Group Berhad's Liabilities

The latest balance sheet data shows that Chin Hin Group Berhad had liabilities of RM1.07b due within a year, and liabilities of RM428.7m falling due after that. Offsetting this, it had RM163.0m in cash and RM712.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM626.0m.

Given Chin Hin Group Berhad has a market capitalization of RM6.72b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 9.4 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. However, it should be some comfort for shareholders to recall that Chin Hin Group Berhad actually grew its EBIT by a hefty 115%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chin Hin Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Chin Hin Group Berhad's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We think that Chin Hin Group Berhad's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Chin Hin Group Berhad has 3 warning signs (and 1 which is potentially serious) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.