These 4 Measures Indicate That DKLS Industries Berhad (KLSE:DKLS) Is Using Debt Safely

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that DKLS Industries Berhad (KLSE:DKLS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for DKLS Industries Berhad

What Is DKLS Industries Berhad's Debt?

As you can see below, DKLS Industries Berhad had RM52.1m of debt at December 2020, down from RM60.9m a year prior. But it also has RM77.3m in cash to offset that, meaning it has RM25.2m net cash.

How Strong Is DKLS Industries Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DKLS Industries Berhad had liabilities of RM75.4m due within 12 months and liabilities of RM42.7m due beyond that. Offsetting these obligations, it had cash of RM77.3m as well as receivables valued at RM60.5m due within 12 months. So it actually has RM19.7m more liquid assets than total liabilities.

This surplus suggests that DKLS Industries Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, DKLS Industries Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that DKLS Industries Berhad saw its EBIT decline by 2.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 DKLS Industries 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. DKLS Industries Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, DKLS Industries Berhad recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that DKLS Industries Berhad has net cash of RM25.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in -RM2.9m. So is DKLS Industries Berhad's debt a risk? It doesn't seem so to us. 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. For example DKLS Industries Berhad has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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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