Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Tong Herr Resources Berhad (KLSE:TONGHER) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Tong Herr Resources Berhad's Debt?
As you can see below, Tong Herr Resources Berhad had RM83.2m of debt at December 2020, down from RM112.6m a year prior. However, its balance sheet shows it holds RM142.6m in cash, so it actually has RM59.4m net cash.
A Look At Tong Herr Resources Berhad's Liabilities
The latest balance sheet data shows that Tong Herr Resources Berhad had liabilities of RM105.3m due within a year, and liabilities of RM19.5m falling due after that. Offsetting this, it had RM142.6m in cash and RM50.9m in receivables that were due within 12 months. So it actually has RM68.6m more liquid assets than total liabilities.
This surplus suggests that Tong Herr Resources 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. Simply put, the fact that Tong Herr Resources Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Tong Herr Resources Berhad grew its EBIT by 78% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tong Herr Resources 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Tong Herr Resources 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. Happily for any shareholders, Tong Herr Resources Berhad 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.
While we empathize with investors who find debt concerning, you should keep in mind that Tong Herr Resources Berhad has net cash of RM59.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM53m, being 106% of its EBIT. When it comes to Tong Herr Resources Berhad's debt, we sufficiently relaxed that our mind turns to the jacuzzi. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Tong Herr Resources Berhad has 2 warning signs we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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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