These 4 Measures Indicate That Zelan Berhad (KLSE:ZELAN) Is Using Debt Extensively

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. As with many other companies Zelan Berhad (KLSE:ZELAN) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zelan Berhad

How Much Debt Does Zelan Berhad Carry?

As you can see below, Zelan Berhad had RM537.5m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.

A Look At Zelan Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Zelan Berhad had liabilities of RM266.9m due within 12 months and liabilities of RM490.8m due beyond that. Offsetting this, it had RM10.2m in cash and RM83.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM664.2m.

The deficiency here weighs heavily on the RM84.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Zelan Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zelan Berhad has a rather high debt to EBITDA ratio of 29.4 which suggests a meaningful debt load. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. Looking on the bright side, Zelan Berhad boosted its EBIT by a silky 98% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Zelan 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent two years, Zelan Berhad recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Zelan Berhad's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Zelan Berhad has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. Take risks, for example - Zelan Berhad has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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