Is Sycal Ventures Berhad (KLSE:SYCAL) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Sycal Ventures Berhad (KLSE:SYCAL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sycal Ventures Berhad

What Is Sycal Ventures Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Sycal Ventures Berhad had debt of RM39.6m, up from RM36.7m in one year. However, because it has a cash reserve of RM6.50m, its net debt is less, at about RM33.1m.

A Look At Sycal Ventures Berhad's Liabilities

The latest balance sheet data shows that Sycal Ventures Berhad had liabilities of RM136.8m due within a year, and liabilities of RM23.8m falling due after that. Offsetting this, it had RM6.50m in cash and RM178.2m in receivables that were due within 12 months. So it actually has RM24.1m more liquid assets than total liabilities.

This surplus suggests that Sycal Ventures Berhad is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While we wouldn't worry about Sycal Ventures Berhad's net debt to EBITDA ratio of 3.5, we think its super-low interest cover of 2.5 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Fortunately, Sycal Ventures Berhad grew its EBIT by 4.5% in the last year, slowly shrinking its debt relative to earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sycal Ventures Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Sycal Ventures Berhad created free cash flow amounting to 15% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We weren't impressed with Sycal Ventures Berhad's conversion of EBIT to free cash flow, and its interest cover made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble staying on top of its total liabilities. Looking at all this data makes us feel a little cautious about Sycal Ventures Berhad's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for Sycal Ventures Berhad you should be aware of, and 1 of them is a bit concerning.

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.