These 4 Measures Indicate That Tong Herr Resources Berhad (KLSE:TONGHER) Is Using Debt Safely

Warren Buffett famously said, '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. As with many other companies Tong Herr Resources Berhad (KLSE:TONGHER) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tong Herr Resources Berhad

How Much Debt Does Tong Herr Resources Berhad Carry?

The image below, which you can click on for greater detail, shows that Tong Herr Resources Berhad had debt of RM75.7m at the end of September 2020, a reduction from RM103.9m over a year. But it also has RM134.2m in cash to offset that, meaning it has RM58.5m net cash.

How Healthy Is Tong Herr Resources Berhad's Balance Sheet?

We can see from the most recent balance sheet that Tong Herr Resources Berhad had liabilities of RM80.0m falling due within a year, and liabilities of RM21.3m due beyond that. Offsetting this, it had RM134.2m in cash and RM53.1m in receivables that were due within 12 months. So it actually has RM86.0m more liquid assets than total liabilities.

This excess liquidity suggests that Tong Herr Resources Berhad is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Tong Herr Resources Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Tong Herr Resources Berhad grew its EBIT by 54% 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 it is Tong Herr Resources 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. Tong Herr Resources Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. 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 generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tong Herr Resources Berhad has net cash of RM58.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM74m, being 111% of its EBIT. The bottom line is that we do not find Tong Herr Resources Berhad's debt levels at all concerning. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Tong Herr Resources Berhad , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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