Does Wong Engineering Corporation Berhad (KLSE:WONG) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Wong Engineering Corporation Berhad (KLSE:WONG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Wong Engineering Corporation Berhad

What Is Wong Engineering Corporation Berhad's Net Debt?

As you can see below, at the end of July 2022, Wong Engineering Corporation Berhad had RM20.8m of debt, up from RM15.2m a year ago. Click the image for more detail. But it also has RM30.1m in cash to offset that, meaning it has RM9.26m net cash.

How Strong Is Wong Engineering Corporation Berhad's Balance Sheet?

We can see from the most recent balance sheet that Wong Engineering Corporation Berhad had liabilities of RM15.4m falling due within a year, and liabilities of RM17.1m due beyond that. Offsetting these obligations, it had cash of RM30.1m as well as receivables valued at RM20.1m due within 12 months. So it actually has RM17.7m more liquid assets than total liabilities.

This surplus suggests that Wong Engineering Corporation Berhad is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Wong Engineering Corporation Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Wong Engineering Corporation Berhad if management cannot prevent a repeat of the 59% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Wong Engineering Corporation Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Wong Engineering Corporation 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. Looking at the most recent three years, Wong Engineering Corporation Berhad recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Wong Engineering Corporation Berhad has net cash of RM9.26m, as well as more liquid assets than liabilities. So we are not troubled with Wong Engineering Corporation Berhad's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Wong Engineering Corporation Berhad has 5 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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. 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.