Is SFP Tech Holdings Berhad (KLSE:SFPTECH) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that SFP Tech Holdings Berhad (KLSE:SFPTECH) does use debt in its business. But the more important question is: how much risk is that debt creating?

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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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does SFP Tech Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that at December 2024 SFP Tech Holdings Berhad had debt of RM30.3m, up from RM12.3m in one year. However, because it has a cash reserve of RM8.80m, its net debt is less, at about RM21.5m.

How Strong Is SFP Tech Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that SFP Tech Holdings Berhad had liabilities of RM56.4m falling due within a year, and liabilities of RM66.8m due beyond that. Offsetting this, it had RM8.80m in cash and RM120.1m in receivables that were due within 12 months. So it actually has RM5.77m more liquid assets than total liabilities.

This state of affairs indicates that SFP Tech Holdings Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the RM552.0m company is struggling for cash, we still think it's worth monitoring its balance sheet.

See our latest analysis for SFP Tech Holdings Berhad

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

SFP Tech Holdings Berhad has a low net debt to EBITDA ratio of only 0.57. And its EBIT covers its interest expense a whopping 10.0 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for SFP Tech Holdings Berhad if management cannot prevent a repeat of the 50% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if SFP Tech Holdings Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts .

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, SFP Tech Holdings Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While SFP Tech Holdings Berhad's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But at least its interest cover is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think SFP Tech Holdings Berhad's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should learn about the 3 warning signs we've spotted with SFP Tech Holdings Berhad (including 2 which shouldn't be ignored) .

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.