We Think Chuan Huat Resources Berhad (KLSE:CHUAN) Can Stay On Top Of Its 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.' 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, Chuan Huat Resources Berhad (KLSE:CHUAN) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chuan Huat Resources Berhad

How Much Debt Does Chuan Huat Resources Berhad Carry?

The image below, which you can click on for greater detail, shows that Chuan Huat Resources Berhad had debt of RM186.5m at the end of December 2021, a reduction from RM224.4m over a year. However, because it has a cash reserve of RM18.0m, its net debt is less, at about RM168.5m.

How Strong Is Chuan Huat Resources Berhad's Balance Sheet?

We can see from the most recent balance sheet that Chuan Huat Resources Berhad had liabilities of RM211.8m falling due within a year, and liabilities of RM38.3m due beyond that. Offsetting this, it had RM18.0m in cash and RM164.1m in receivables that were due within 12 months. So it has liabilities totalling RM68.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM86.0m, so it does suggest shareholders should keep an eye on Chuan Huat Resources Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Chuan Huat Resources Berhad has a debt to EBITDA ratio of 4.9 and its EBIT covered its interest expense 4.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, it should be some comfort for shareholders to recall that Chuan Huat Resources Berhad actually grew its EBIT by a hefty 543%, 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 you can't view debt in total isolation; since Chuan Huat Resources Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Chuan Huat Resources Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Chuan Huat Resources Berhad's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. But truth be told its net debt to EBITDA had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Chuan Huat Resources Berhad is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example Chuan Huat Resources Berhad has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.