Sycal Ventures Berhad (KLSE:SYCAL) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Sycal Ventures Berhad (KLSE:SYCAL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sycal Ventures Berhad

What Is Sycal Ventures Berhad's Debt?

The image below, which you can click on for greater detail, shows that Sycal Ventures Berhad had debt of RM44.4m at the end of September 2020, a reduction from RM48.7m over a year. However, it does have RM7.91m in cash offsetting this, leading to net debt of about RM36.4m.

How Healthy Is Sycal Ventures Berhad's Balance Sheet?

According to the last reported balance sheet, Sycal Ventures Berhad had liabilities of RM152.2m due within 12 months, and liabilities of RM51.0m due beyond 12 months. On the other hand, it had cash of RM7.91m and RM153.4m worth of receivables due within a year. So its liabilities total RM42.0m more than the combination of its cash and short-term receivables.

Sycal Ventures Berhad has a market capitalization of RM106.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 2.5, we think its super-low interest cover of 2.4 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The bad news is that Sycal Ventures Berhad saw its EBIT decline by 20% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is Sycal Ventures 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Sycal Ventures Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Sycal Ventures Berhad's EBIT growth rate left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, it seems to us that Sycal Ventures Berhad's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Sycal Ventures Berhad (at least 1 which is a bit concerning) , 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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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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