Is Knusford Berhad (KLSE:KNUSFOR) Using Too Much 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. Importantly, Knusford Berhad (KLSE:KNUSFOR) does carry debt. But is this debt a concern to shareholders?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Knusford Berhad

How Much Debt Does Knusford Berhad Carry?

The image below, which you can click on for greater detail, shows that Knusford Berhad had debt of RM8.40m at the end of September 2020, a reduction from RM12.5m over a year. However, its balance sheet shows it holds RM46.9m in cash, so it actually has RM38.5m net cash.

How Strong Is Knusford Berhad's Balance Sheet?

We can see from the most recent balance sheet that Knusford Berhad had liabilities of RM143.9m falling due within a year, and liabilities of RM7.02m due beyond that. On the other hand, it had cash of RM46.9m and RM195.1m worth of receivables due within a year. So it can boast RM91.1m more liquid assets than total liabilities.

This luscious liquidity implies that Knusford Berhad's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Knusford Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Knusford Berhad grew its EBIT by 1,708% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Knusford 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Knusford Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Knusford Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Knusford Berhad has RM38.5m in net cash and a strong balance sheet. And it impressed us with free cash flow of -RM2.0m, being 113% of its EBIT. The bottom line is that Knusford Berhad's use of debt is absolutely fine. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Knusford Berhad has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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