Stock Analysis

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

KLSE:SYCAL
Source: Shutterstock

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.' 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?

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. 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. 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. 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

How Much Debt Does Sycal Ventures Berhad Carry?

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, because it has a cash reserve of RM7.91m, its net debt is less, at about RM36.4m.

debt-equity-history-analysis
KLSE:SYCAL Debt to Equity History March 10th 2021

How Strong 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. Offsetting these obligations, it had cash of RM7.91m as well as receivables valued at RM153.4m due within 12 months. So it has liabilities totalling RM42.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Sycal Ventures Berhad has a market capitalization of RM108.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Sycal Ventures Berhad's debt to EBITDA ratio (2.5) suggests that it uses some debt, its interest cover is very weak, at 2.4, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. 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 you can't view debt in total isolation; since Sycal Ventures Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Sycal Ventures Berhad's EBIT growth rate and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. 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. 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. Be aware that Sycal Ventures Berhad is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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