Is Sarawak Consolidated Industries Berhad (KLSE:SCIB) A Risky Investment?

Warren Buffett famously said, '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. Importantly, Sarawak Consolidated Industries Berhad (KLSE:SCIB) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sarawak Consolidated Industries Berhad

How Much Debt Does Sarawak Consolidated Industries Berhad Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Sarawak Consolidated Industries Berhad had debt of RM54.5m, up from RM40.4m in one year. However, it also had RM18.5m in cash, and so its net debt is RM36.0m.

How Healthy Is Sarawak Consolidated Industries Berhad's Balance Sheet?

The latest balance sheet data shows that Sarawak Consolidated Industries Berhad had liabilities of RM82.1m due within a year, and liabilities of RM50.7m falling due after that. Offsetting this, it had RM18.5m in cash and RM94.2m in receivables that were due within 12 months. So it has liabilities totalling RM20.0m more than its cash and near-term receivables, combined.

Of course, Sarawak Consolidated Industries Berhad has a market capitalization of RM118.8m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sarawak Consolidated Industries Berhad's net debt is sitting at a very reasonable 2.5 times its EBITDA, while its EBIT covered its interest expense just 3.7 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Pleasingly, Sarawak Consolidated Industries Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 471% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sarawak Consolidated Industries Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last two years, Sarawak Consolidated Industries 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

Based on what we've seen Sarawak Consolidated Industries Berhad is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Sarawak Consolidated Industries Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 Sarawak Consolidated Industries Berhad is showing 1 warning sign in our investment analysis , you should know about...

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.