Is SAM Engineering & Equipment (M) Berhad (KLSE:SAM) A Risky Investment?

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.' 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. We can see that SAM Engineering & Equipment (M) Berhad (KLSE:SAM) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SAM Engineering & Equipment (M) Berhad

What Is SAM Engineering & Equipment (M) Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 SAM Engineering & Equipment (M) Berhad had debt of RM204.9m, up from RM87.0m in one year. However, it does have RM14.1m in cash offsetting this, leading to net debt of about RM190.8m.

How Strong Is SAM Engineering & Equipment (M) Berhad's Balance Sheet?

The latest balance sheet data shows that SAM Engineering & Equipment (M) Berhad had liabilities of RM419.8m due within a year, and liabilities of RM35.4m falling due after that. On the other hand, it had cash of RM14.1m and RM453.7m worth of receivables due within a year. So it actually has RM12.7m more liquid assets than total liabilities.

Having regard to SAM Engineering & Equipment (M) Berhad's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the RM2.59b company is short on cash, but still worth keeping an eye on the balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

SAM Engineering & Equipment (M) Berhad has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 42.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that SAM Engineering & Equipment (M) Berhad has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SAM Engineering & Equipment (M) Berhad will need earnings to service that debt. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, SAM Engineering & Equipment (M) Berhad recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

The good news is that SAM Engineering & Equipment (M) Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that SAM Engineering & Equipment (M) Berhad can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for SAM Engineering & Equipment (M) Berhad (1 is a bit unpleasant!) that you should be aware of before investing here.

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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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.