SAM Engineering & Equipment (M) Berhad (KLSE:SAM) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies SAM Engineering & Equipment (M) Berhad (KLSE:SAM) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

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

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

As you can see below, at the end of June 2022, SAM Engineering & Equipment (M) Berhad had RM284.1m of debt, up from RM86.0m a year ago. Click the image for more detail. However, because it has a cash reserve of RM31.6m, its net debt is less, at about RM252.5m.

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

We can see from the most recent balance sheet that SAM Engineering & Equipment (M) Berhad had liabilities of RM581.1m falling due within a year, and liabilities of RM48.6m due beyond that. Offsetting these obligations, it had cash of RM31.6m as well as receivables valued at RM553.3m due within 12 months. So it has liabilities totalling RM44.8m more than its cash and near-term receivables, combined.

Having regard to SAM Engineering & Equipment (M) Berhad's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the RM2.76b company is struggling for cash, we still think it's worth monitoring its 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).

We'd say that SAM Engineering & Equipment (M) Berhad's moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its commanding EBIT of 38.4 times its interest expense, implies the debt load is as light as a peacock feather. In addition to that, we're happy to report that SAM Engineering & Equipment (M) Berhad has boosted its EBIT by 42%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SAM Engineering & Equipment (M) Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, SAM Engineering & Equipment (M) Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

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. All these things considered, it appears that SAM Engineering & Equipment (M) Berhad can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - SAM Engineering & Equipment (M) Berhad has 2 warning signs we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.