We Think ES Ceramics Technology Berhad (KLSE:ESCERAM) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that ES Ceramics Technology Berhad (KLSE:ESCERAM) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ES Ceramics Technology Berhad

How Much Debt Does ES Ceramics Technology Berhad Carry?

As you can see below, at the end of November 2022, ES Ceramics Technology Berhad had RM23.3m of debt, up from RM219.8k a year ago. Click the image for more detail. However, its balance sheet shows it holds RM47.5m in cash, so it actually has RM24.3m net cash.

How Healthy Is ES Ceramics Technology Berhad's Balance Sheet?

According to the last reported balance sheet, ES Ceramics Technology Berhad had liabilities of RM96.1m due within 12 months, and liabilities of RM24.6m due beyond 12 months. Offsetting these obligations, it had cash of RM47.5m as well as receivables valued at RM95.9m due within 12 months. So it actually has RM22.8m more liquid assets than total liabilities.

It's good to see that ES Ceramics Technology Berhad has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, ES Ceramics Technology Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact ES Ceramics Technology Berhad's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since ES Ceramics Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ES Ceramics Technology 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. During the last three years, ES Ceramics Technology Berhad generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd 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 ES Ceramics Technology Berhad has net cash of RM24.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM22m, being 87% of its EBIT. So we don't think ES Ceramics Technology Berhad's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for ES Ceramics Technology Berhad that you should be aware of before investing here.

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.

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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.