Here's Why Sunway Construction Group Berhad (KLSE:SUNCON) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Sunway Construction Group Berhad (KLSE:SUNCON) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sunway Construction Group Berhad

What Is Sunway Construction Group Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Sunway Construction Group Berhad had RM300.0m of debt, an increase on RM286.2m, over one year. However, its balance sheet shows it holds RM640.1m in cash, so it actually has RM340.0m net cash.

A Look At Sunway Construction Group Berhad's Liabilities

The latest balance sheet data shows that Sunway Construction Group Berhad had liabilities of RM1.19b due within a year, and liabilities of RM72.7m falling due after that. Offsetting this, it had RM640.1m in cash and RM1.07b in receivables that were due within 12 months. So it actually has RM440.6m more liquid assets than total liabilities.

This surplus suggests that Sunway Construction Group Berhad is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Sunway Construction Group Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Sunway Construction Group Berhad if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sunway Construction Group 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. While Sunway Construction Group Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Sunway Construction Group Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Sunway Construction Group Berhad has RM340.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM90m, being 106% of its EBIT. So we don't think Sunway Construction Group Berhad's use of debt is risky. 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. For example, we've discovered 3 warning signs for Sunway Construction Group Berhad that you should be aware of before investing here.

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. 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.
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