These 4 Measures Indicate That Poly Glass Fibre (M) Bhd (KLSE:POLY) Is Using Debt Reasonably Well

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.' 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 Poly Glass Fibre (M) Bhd. (KLSE:POLY) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Poly Glass Fibre (M) Bhd

What Is Poly Glass Fibre (M) Bhd's Debt?

You can click the graphic below for the historical numbers, but it shows that Poly Glass Fibre (M) Bhd had RM21.6m of debt in August 2021, down from RM25.7m, one year before. However, it also had RM6.97m in cash, and so its net debt is RM14.7m.

How Healthy Is Poly Glass Fibre (M) Bhd's Balance Sheet?

The latest balance sheet data shows that Poly Glass Fibre (M) Bhd had liabilities of RM15.4m due within a year, and liabilities of RM43.3m falling due after that. Offsetting this, it had RM6.97m in cash and RM21.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM30.1m.

This deficit isn't so bad because Poly Glass Fibre (M) Bhd is worth RM107.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Poly Glass Fibre (M) Bhd's net debt is only 0.98 times its EBITDA. And its EBIT covers its interest expense a whopping 14.7 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Poly Glass Fibre (M) Bhd saw its EBIT drop by 2.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Poly Glass Fibre (M) Bhd'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 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. During the last three years, Poly Glass Fibre (M) Bhd produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Poly Glass Fibre (M) Bhd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Taking all this data into account, it seems to us that Poly Glass Fibre (M) Bhd takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Poly Glass Fibre (M) Bhd is showing 4 warning signs in our investment analysis , and 1 of those is a bit concerning...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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