We Think Kumpulan Perangsang Selangor Berhad (KLSE:KPS) Is Taking Some Risk With Its 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Kumpulan Perangsang Selangor Berhad (KLSE:KPS) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

View our latest analysis for Kumpulan Perangsang Selangor Berhad

What Is Kumpulan Perangsang Selangor Berhad's Debt?

The image below, which you can click on for greater detail, shows that Kumpulan Perangsang Selangor Berhad had debt of RM564.1m at the end of September 2020, a reduction from RM636.0m over a year. However, because it has a cash reserve of RM405.9m, its net debt is less, at about RM158.2m.

How Healthy Is Kumpulan Perangsang Selangor Berhad's Balance Sheet?

The latest balance sheet data shows that Kumpulan Perangsang Selangor Berhad had liabilities of RM429.8m due within a year, and liabilities of RM696.4m falling due after that. On the other hand, it had cash of RM405.9m and RM367.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM353.1m.

This deficit is considerable relative to its market capitalization of RM432.6m, so it does suggest shareholders should keep an eye on Kumpulan Perangsang Selangor Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

Kumpulan Perangsang Selangor Berhad has a very low debt to EBITDA ratio of 1.4 so it is strange to see weak interest coverage, with last year's EBIT being only 2.3 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We note that Kumpulan Perangsang Selangor Berhad grew its EBIT by 26% in the last year, and that should make it 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 Kumpulan Perangsang Selangor Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Kumpulan Perangsang Selangor 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

Mulling over Kumpulan Perangsang Selangor Berhad's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at growing its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Kumpulan Perangsang Selangor Berhad's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should learn about the 4 warning signs we've spotted with Kumpulan Perangsang Selangor Berhad (including 2 which can't be ignored) .

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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