Is SAM Engineering & Equipment (M) Berhad (KLSE:SAM) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that SAM Engineering & Equipment (M) Berhad (KLSE:SAM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

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

How Much Debt Does SAM Engineering & Equipment (M) Berhad Carry?

The image below, which you can click on for greater detail, shows that SAM Engineering & Equipment (M) Berhad had debt of RM87.0m at the end of December 2020, a reduction from RM115.4m over a year. On the flip side, it has RM26.9m in cash leading to net debt of about RM60.1m.

A Look At SAM Engineering & Equipment (M) Berhad's Liabilities

According to the last reported balance sheet, SAM Engineering & Equipment (M) Berhad had liabilities of RM260.3m due within 12 months, and liabilities of RM54.8m due beyond 12 months. Offsetting these obligations, it had cash of RM26.9m as well as receivables valued at RM325.3m due within 12 months. So it actually has RM37.0m more liquid assets than total liabilities.

This short term liquidity is a sign that SAM Engineering & Equipment (M) Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched.

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 0.47. And its EBIT easily covers its interest expense, being 26.6 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for SAM Engineering & Equipment (M) Berhad if management cannot prevent a repeat of the 22% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since SAM Engineering & Equipment (M) Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, SAM Engineering & Equipment (M) Berhad actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We feel some trepidation about SAM Engineering & Equipment (M) Berhad's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that SAM Engineering & Equipment (M) Berhad is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with SAM Engineering & Equipment (M) Berhad , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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