Is Coastal Contracts Bhd (KLSE:COASTAL) Using Debt In A Risky Way?

Simply Wall St
June 04, 2021
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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, Coastal Contracts Bhd (KLSE:COASTAL) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Coastal Contracts Bhd

What Is Coastal Contracts Bhd's Debt?

As you can see below, Coastal Contracts Bhd had RM102.9m of debt at March 2021, down from RM256.2m a year prior. But it also has RM286.7m in cash to offset that, meaning it has RM183.8m net cash.

KLSE:COASTAL Debt to Equity History June 4th 2021

A Look At Coastal Contracts Bhd's Liabilities

Zooming in on the latest balance sheet data, we can see that Coastal Contracts Bhd had liabilities of RM234.9m due within 12 months and liabilities of RM61.3m due beyond that. Offsetting these obligations, it had cash of RM286.7m as well as receivables valued at RM201.6m due within 12 months. So it actually has RM192.1m more liquid assets than total liabilities.

This surplus liquidity suggests that Coastal Contracts Bhd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Coastal Contracts Bhd boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Coastal Contracts Bhd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Coastal Contracts Bhd made a loss at the EBIT level, and saw its revenue drop to RM159m, which is a fall of 24%. That makes us nervous, to say the least.

So How Risky Is Coastal Contracts Bhd?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Coastal Contracts Bhd lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through RM12m of cash and made a loss of RM158m. Given it only has net cash of RM183.8m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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 1 warning sign with Coastal Contracts Bhd , and understanding them should be part of your investment process.

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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