Here's Why Ho Wah Genting Berhad (KLSE:HWGB) Can Afford Some Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Ho Wah Genting Berhad (KLSE:HWGB) 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ho Wah Genting Berhad

What Is Ho Wah Genting Berhad's Net Debt?

As you can see below, Ho Wah Genting Berhad had RM32.8m of debt, at April 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has RM13.5m in cash leading to net debt of about RM19.3m.

How Strong Is Ho Wah Genting Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ho Wah Genting Berhad had liabilities of RM92.6m due within 12 months and liabilities of RM13.3m due beyond that. Offsetting these obligations, it had cash of RM13.5m as well as receivables valued at RM17.1m due within 12 months. So it has liabilities totalling RM75.3m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM92.6m, so it does suggest shareholders should keep an eye on Ho Wah Genting Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ho Wah Genting Berhad will need earnings to service that debt. 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.

Over 12 months, Ho Wah Genting Berhad reported revenue of RM451m, which is a gain of 53%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Ho Wah Genting Berhad's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost RM1.4m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through RM18m of cash over the last year. So in short it's a really risky stock. 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. For instance, we've identified 4 warning signs for Ho Wah Genting Berhad (2 don't sit too well with us) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.