Hap Seng Consolidated Berhad (KLSE:HAPSENG) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Hap Seng Consolidated Berhad (KLSE:HAPSENG) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hap Seng Consolidated Berhad

How Much Debt Does Hap Seng Consolidated Berhad Carry?

As you can see below, Hap Seng Consolidated Berhad had RM6.49b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have RM3.05b in cash offsetting this, leading to net debt of about RM3.44b.

How Healthy Is Hap Seng Consolidated Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hap Seng Consolidated Berhad had liabilities of RM4.52b due within 12 months and liabilities of RM4.07b due beyond that. On the other hand, it had cash of RM3.05b and RM2.87b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM2.67b.

Given Hap Seng Consolidated Berhad has a market capitalization of RM19.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hap Seng Consolidated Berhad has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.0 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Hap Seng Consolidated Berhad grew its EBIT by 7.0% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hap Seng Consolidated 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. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Hap Seng Consolidated Berhad recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Hap Seng Consolidated Berhad's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity to grow its EBIT. Looking at all this data makes us feel a little cautious about Hap Seng Consolidated Berhad's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Hap Seng Consolidated Berhad (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. 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.
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