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.' 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. As with many other companies Hextar Industries Berhad (KLSE:HEXIND) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hextar Industries Berhad's Debt?
You can click the graphic below for the historical numbers, but it shows that as of February 2021 Hextar Industries Berhad had RM60.7m of debt, an increase on RM58.1m, over one year. However, it also had RM32.4m in cash, and so its net debt is RM28.3m.
How Strong Is Hextar Industries Berhad's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hextar Industries Berhad had liabilities of RM35.8m due within 12 months and liabilities of RM50.5m due beyond that. Offsetting these obligations, it had cash of RM32.4m as well as receivables valued at RM40.2m due within 12 months. So it has liabilities totalling RM13.7m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Hextar Industries Berhad has a market capitalization of RM46.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Hextar Industries Berhad's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 3.6 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, Hextar Industries Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM8.9m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Hextar Industries Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Looking at the most recent year, Hextar Industries Berhad recorded free cash flow of 23% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Both Hextar Industries Berhad's interest cover and its conversion of EBIT to free cash flow were discouraging. At least its level of total liabilities gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Hextar Industries Berhad is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Hextar Industries Berhad (of which 2 are concerning!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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