Samchem Holdings Berhad (KLSE:SAMCHEM) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Samchem Holdings Berhad (KLSE:SAMCHEM) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Samchem Holdings Berhad

What Is Samchem Holdings Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Samchem Holdings Berhad had RM143.4m of debt in December 2022, down from RM224.8m, one year before. On the flip side, it has RM75.3m in cash leading to net debt of about RM68.1m.

How Healthy Is Samchem Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Samchem Holdings Berhad had liabilities of RM210.9m due within a year, and liabilities of RM21.6m falling due after that. Offsetting these obligations, it had cash of RM75.3m as well as receivables valued at RM208.7m due within 12 months. So it actually has RM51.4m more liquid assets than total liabilities.

This excess liquidity suggests that Samchem Holdings Berhad is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders.

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).

With net debt sitting at just 1.1 times EBITDA, Samchem Holdings Berhad is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.3 times the interest expense over the last year. It is just as well that Samchem Holdings Berhad's load is not too heavy, because its EBIT was down 51% 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 Samchem Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Samchem Holdings Berhad produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Samchem Holdings Berhad's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Samchem Holdings Berhad is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Samchem Holdings Berhad has 3 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.