These 4 Measures Indicate That DKSH Holdings (Malaysia) Berhad (KLSE:DKSH) Is Using Debt Extensively

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.' 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. As with many other companies DKSH Holdings (Malaysia) Berhad (KLSE:DKSH) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for DKSH Holdings (Malaysia) Berhad

How Much Debt Does DKSH Holdings (Malaysia) Berhad Carry?

As you can see below, at the end of September 2020, DKSH Holdings (Malaysia) Berhad had RM729.5m of debt, up from RM685.6m a year ago. Click the image for more detail. On the flip side, it has RM96.9m in cash leading to net debt of about RM632.5m.

A Look At DKSH Holdings (Malaysia) Berhad's Liabilities

According to the last reported balance sheet, DKSH Holdings (Malaysia) Berhad had liabilities of RM1.56b due within 12 months, and liabilities of RM598.5m due beyond 12 months. On the other hand, it had cash of RM96.9m and RM1.43b worth of receivables due within a year. So it has liabilities totalling RM628.2m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's RM551.8m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

DKSH Holdings (Malaysia) Berhad's debt is 3.9 times its EBITDA, and its EBIT cover its interest expense 3.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that DKSH Holdings (Malaysia) Berhad grew its EBIT a smooth 49% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine DKSH Holdings (Malaysia) Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, DKSH Holdings (Malaysia) Berhad recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

DKSH Holdings (Malaysia) Berhad's level of total liabilities and net debt to EBITDA 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 DKSH Holdings (Malaysia) Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - DKSH Holdings (Malaysia) Berhad has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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