Seremban Engineering Berhad (KLSE:SEB) Has A Somewhat Strained Balance Sheet

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. We note that Seremban Engineering Berhad (KLSE:SEB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Seremban Engineering Berhad

How Much Debt Does Seremban Engineering Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Seremban Engineering Berhad had RM57.2m of debt, an increase on RM39.7m, over one year. On the flip side, it has RM9.28m in cash leading to net debt of about RM47.9m.

How Healthy Is Seremban Engineering Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Seremban Engineering Berhad had liabilities of RM114.6m due within 12 months and liabilities of RM4.18m due beyond that. Offsetting these obligations, it had cash of RM9.28m as well as receivables valued at RM98.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM11.5m.

Given Seremban Engineering Berhad has a market capitalization of RM58.6m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 5.3 hit our confidence in Seremban Engineering Berhad like a one-two punch to the gut. The debt burden here is substantial. Given the debt load, it's hardly ideal that Seremban Engineering Berhad's EBIT was pretty flat over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Seremban Engineering 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Seremban Engineering Berhad saw substantial negative free cash flow, in total. 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

On the face of it, Seremban Engineering Berhad's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. Overall, we think it's fair to say that Seremban Engineering Berhad has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Seremban Engineering Berhad (of which 1 is significant!) you should know about.

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.