Is Kejuruteraanstera Berhad (KLSE:KAB) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Kejuruteraan Asastera Berhad (KLSE:KAB) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kejuruteraanstera Berhad

What Is Kejuruteraanstera Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Kejuruteraanstera Berhad had RM26.1m of debt, an increase on RM9.48m, over one year. However, it also had RM8.59m in cash, and so its net debt is RM17.5m.

How Strong Is Kejuruteraanstera Berhad's Balance Sheet?

We can see from the most recent balance sheet that Kejuruteraanstera Berhad had liabilities of RM78.9m falling due within a year, and liabilities of RM10.2m due beyond that. Offsetting this, it had RM8.59m in cash and RM116.3m in receivables that were due within 12 months. So it can boast RM35.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Kejuruteraanstera Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. But either way, Kejuruteraanstera Berhad has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kejuruteraanstera Berhad's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 23.9 times, makes us even more comfortable. Importantly, Kejuruteraanstera Berhad's EBIT fell a jaw-dropping 34% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kejuruteraanstera 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's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Kejuruteraanstera Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither Kejuruteraanstera Berhad's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Kejuruteraanstera 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 Kejuruteraanstera Berhad (of which 2 are a bit unpleasant!) you should know about.

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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