Is HSS Engineers Berhad (KLSE:HSSEB) A Risky Investment?

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.' 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 note that HSS Engineers Berhad (KLSE:HSSEB) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for HSS Engineers Berhad

What Is HSS Engineers Berhad's Debt?

As you can see below, HSS Engineers Berhad had RM52.5m of debt at June 2021, down from RM67.0m a year prior. On the flip side, it has RM22.3m in cash leading to net debt of about RM30.2m.

How Strong Is HSS Engineers Berhad's Balance Sheet?

We can see from the most recent balance sheet that HSS Engineers Berhad had liabilities of RM78.3m falling due within a year, and liabilities of RM54.9m due beyond that. On the other hand, it had cash of RM22.3m and RM148.6m worth of receivables due within a year. So it actually has RM37.7m more liquid assets than total liabilities.

This surplus suggests that HSS Engineers Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While HSS Engineers Berhad's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly HSS Engineers Berhad's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HSS Engineers Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, HSS Engineers Berhad generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, HSS Engineers Berhad's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And its level of total liabilities is good too. Looking at the bigger picture, we think HSS Engineers Berhad's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. We've identified 1 warning sign with HSS Engineers Berhad , and understanding them should be part of your investment process.

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. 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.
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