Superlon Holdings Berhad (KLSE:SUPERLN) Seems To Use Debt Quite Sensibly

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 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 Superlon Holdings Berhad (KLSE:SUPERLN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Superlon Holdings Berhad

How Much Debt Does Superlon Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that Superlon Holdings Berhad had debt of RM8.95m at the end of January 2021, a reduction from RM11.7m over a year. But it also has RM26.1m in cash to offset that, meaning it has RM17.2m net cash.

How Strong Is Superlon Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Superlon Holdings Berhad had liabilities of RM13.5m due within a year, and liabilities of RM13.9m falling due after that. Offsetting these obligations, it had cash of RM26.1m as well as receivables valued at RM20.0m due within 12 months. So it can boast RM18.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Superlon Holdings Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Superlon Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Superlon Holdings Berhad grew its EBIT by 2.5% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Superlon Holdings Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Superlon Holdings 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. In the last three years, Superlon Holdings Berhad's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Superlon Holdings Berhad has net cash of RM17.2m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 2.5% in the last twelve months. So is Superlon Holdings Berhad's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Superlon Holdings Berhad , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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