Wong Engineering Corporation Berhad (KLSE:WONG) Seems To Use Debt Rather Sparingly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Wong Engineering Corporation Berhad (KLSE:WONG) does use debt in its business. But is this debt a concern to shareholders?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Wong Engineering Corporation Berhad

How Much Debt Does Wong Engineering Corporation Berhad Carry?

As you can see below, Wong Engineering Corporation Berhad had RM15.2m of debt at July 2021, down from RM17.2m a year prior. But it also has RM23.5m in cash to offset that, meaning it has RM8.35m net cash.

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

According to the last reported balance sheet, Wong Engineering Corporation Berhad had liabilities of RM14.7m due within 12 months, and liabilities of RM13.3m due beyond 12 months. Offsetting this, it had RM23.5m in cash and RM24.4m in receivables that were due within 12 months. So it can boast RM20.0m more liquid assets than total liabilities.

This surplus suggests that Wong Engineering Corporation Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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.

In addition to that, we're happy to report that Wong Engineering Corporation Berhad has boosted its EBIT by 76%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Wong Engineering Corporation Berhad will need earnings to service that debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Happily for any shareholders, Wong Engineering Corporation 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Wong Engineering Corporation Berhad has RM8.35m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in RM8.7m. So is Wong Engineering Corporation Berhad's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Wong Engineering Corporation Berhad you should know about.

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.