Is FITTERS Diversified Berhad (KLSE:FITTERS) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that FITTERS Diversified Berhad (KLSE:FITTERS) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for FITTERS Diversified Berhad

How Much Debt Does FITTERS Diversified Berhad Carry?

The image below, which you can click on for greater detail, shows that FITTERS Diversified Berhad had debt of RM85.0m at the end of December 2020, a reduction from RM93.7m over a year. However, it does have RM23.6m in cash offsetting this, leading to net debt of about RM61.4m.

How Strong Is FITTERS Diversified Berhad's Balance Sheet?

We can see from the most recent balance sheet that FITTERS Diversified Berhad had liabilities of RM119.0m falling due within a year, and liabilities of RM20.7m due beyond that. Offsetting this, it had RM23.6m in cash and RM84.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM31.8m.

This deficit isn't so bad because FITTERS Diversified Berhad is worth RM105.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since FITTERS Diversified 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.

In the last year FITTERS Diversified Berhad had a loss before interest and tax, and actually shrunk its revenue by 18%, to RM216m. We would much prefer see growth.

Caveat Emptor

Not only did FITTERS Diversified Berhad's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping RM13m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of RM13m into a profit. In the meantime, we consider the stock very risky. 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. To that end, you should learn about the 3 warning signs we've spotted with FITTERS Diversified Berhad (including 1 which is a bit unpleasant) .

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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