We Think Kelington Group Berhad (KLSE:KGB) Is Taking Some Risk With Its Debt

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. As with many other companies Kelington Group Berhad (KLSE:KGB) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kelington Group Berhad

What Is Kelington Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Kelington Group Berhad had debt of RM61.8m, up from RM37.9m in one year. However, because it has a cash reserve of RM58.7m, its net debt is less, at about RM3.10m.

How Healthy Is Kelington Group Berhad's Balance Sheet?

According to the last reported balance sheet, Kelington Group Berhad had liabilities of RM136.8m due within 12 months, and liabilities of RM31.7m due beyond 12 months. On the other hand, it had cash of RM58.7m and RM194.3m worth of receivables due within a year. So it actually has RM84.4m more liquid assets than total liabilities.

This surplus suggests that Kelington Group Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, Kelington Group Berhad has a very light debt load indeed.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Kelington Group Berhad has net debt of just 0.14 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.0 times, which is more than adequate. In fact Kelington Group Berhad's saving grace is its low debt levels, because its EBIT has tanked 35% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Kelington Group Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Kelington Group Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Kelington Group Berhad's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But at least its net debt to EBITDA is a gleaming silver lining to those clouds. Looking at all the angles mentioned above, it does seem to us that Kelington Group Berhad is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Kelington Group Berhad you should be aware of.

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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