Is Sunmow Holding Berhad (KLSE:SUNMOW) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Sunmow Holding Berhad (KLSE:SUNMOW) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sunmow Holding Berhad

What Is Sunmow Holding Berhad's Net Debt?

As you can see below, Sunmow Holding Berhad had RM11.0m of debt at June 2024, down from RM11.8m a year prior. However, its balance sheet shows it holds RM21.8m in cash, so it actually has RM10.8m net cash.

How Healthy Is Sunmow Holding Berhad's Balance Sheet?

According to the last reported balance sheet, Sunmow Holding Berhad had liabilities of RM91.9m due within 12 months, and liabilities of RM4.77m due beyond 12 months. Offsetting this, it had RM21.8m in cash and RM64.0m in receivables that were due within 12 months. So its liabilities total RM10.9m more than the combination of its cash and short-term receivables.

Given Sunmow Holding Berhad has a market capitalization of RM386.0m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Sunmow Holding Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Sunmow Holding Berhad has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sunmow Holding 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 company can only pay off debt with cold hard cash, not accounting profits. While Sunmow Holding 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. Happily for any shareholders, Sunmow Holding Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sunmow Holding Berhad has RM10.8m in net cash. And it impressed us with free cash flow of RM11m, being 101% of its EBIT. So we are not troubled with Sunmow Holding Berhad's debt use. 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. We've identified 2 warning signs with Sunmow Holding Berhad (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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.