We Think SKB Shutters Corporation Berhad (KLSE:SKBSHUT) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that SKB Shutters Corporation Berhad (KLSE:SKBSHUT) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for SKB Shutters Corporation Berhad

What Is SKB Shutters Corporation Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 SKB Shutters Corporation Berhad had RM77.1m of debt, an increase on RM48.2m, over one year. On the flip side, it has RM24.4m in cash leading to net debt of about RM52.7m.

A Look At SKB Shutters Corporation Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that SKB Shutters Corporation Berhad had liabilities of RM46.1m due within 12 months and liabilities of RM64.9m due beyond that. Offsetting these obligations, it had cash of RM24.4m as well as receivables valued at RM18.5m due within 12 months. So it has liabilities totalling RM68.1m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RM95.7m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

SKB Shutters Corporation Berhad's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its commanding EBIT of 11.1 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, SKB Shutters Corporation Berhad grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is SKB Shutters Corporation 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, SKB Shutters Corporation Berhad actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We feel some trepidation about SKB Shutters Corporation Berhad's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its EBIT growth rate and interest cover give us some confidence in its ability to manage its debt. We think that SKB Shutters Corporation Berhad's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SKB Shutters Corporation Berhad is showing 4 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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.

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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.