Favelle Favco Berhad (KLSE:FAVCO) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Favelle Favco Berhad (KLSE:FAVCO) 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Favelle Favco Berhad

What Is Favelle Favco Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Favelle Favco Berhad had RM51.9m of debt, an increase on RM48.7m, over one year. But on the other hand it also has RM301.0m in cash, leading to a RM249.1m net cash position.

How Strong Is Favelle Favco Berhad's Balance Sheet?

We can see from the most recent balance sheet that Favelle Favco Berhad had liabilities of RM510.2m falling due within a year, and liabilities of RM57.6m due beyond that. Offsetting these obligations, it had cash of RM301.0m as well as receivables valued at RM308.1m due within 12 months. So it actually has RM41.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Favelle Favco Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Favelle Favco Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Favelle Favco Berhad's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Favelle Favco Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Favelle Favco 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, Favelle Favco Berhad reported free cash flow worth 16% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Favelle Favco Berhad has net cash of RM249.1m, as well as more liquid assets than liabilities. So we don't have any problem with Favelle Favco Berhad's use of debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Favelle Favco Berhad's dividend history, without delay!

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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