Does Texchem Resources Bhd (KLSE:TEXCHEM) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Texchem Resources Bhd (KLSE:TEXCHEM) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Texchem Resources Bhd

How Much Debt Does Texchem Resources Bhd Carry?

As you can see below, at the end of September 2021, Texchem Resources Bhd had RM156.5m of debt, up from RM149.5m a year ago. Click the image for more detail. However, it does have RM73.5m in cash offsetting this, leading to net debt of about RM83.1m.

How Strong Is Texchem Resources Bhd's Balance Sheet?

We can see from the most recent balance sheet that Texchem Resources Bhd had liabilities of RM298.5m falling due within a year, and liabilities of RM93.8m due beyond that. On the other hand, it had cash of RM73.5m and RM171.6m worth of receivables due within a year. So it has liabilities totalling RM147.3m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM154.2m, so it does suggest shareholders should keep an eye on Texchem Resources Bhd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Texchem Resources Bhd has a quite reasonable net debt to EBITDA multiple of 1.8, its interest cover seems weak, at 2.1. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. It is well worth noting that Texchem Resources Bhd's EBIT shot up like bamboo after rain, gaining 79% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Texchem Resources Bhd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Texchem Resources Bhd 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.

Our View

Texchem Resources Bhd's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. But truth be told its interest cover had us nibbling our nails. Considering this range of data points, we think Texchem Resources Bhd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Texchem Resources Bhd you should be aware of.

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. 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.