Here's Why Euro Holdings Berhad (KLSE:EURO) Can Afford Some Debt

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. Importantly, Euro Holdings Berhad (KLSE:EURO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

View our latest analysis for Euro Holdings Berhad

What Is Euro Holdings Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Euro Holdings Berhad had debt of RM30.9m at the end of December 2020, a reduction from RM55.2m over a year. On the flip side, it has RM1.57m in cash leading to net debt of about RM29.3m.

How Strong Is Euro Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Euro Holdings Berhad had liabilities of RM62.5m due within a year, and liabilities of RM9.56m falling due after that. Offsetting these obligations, it had cash of RM1.57m as well as receivables valued at RM49.0m due within 12 months. So its liabilities total RM21.4m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Euro Holdings Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM2.67b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Euro Holdings Berhad has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Euro Holdings 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.

Over 12 months, Euro Holdings Berhad made a loss at the EBIT level, and saw its revenue drop to RM67m, which is a fall of 6.3%. That's not what we would hope to see.

Caveat Emptor

Importantly, Euro Holdings Berhad had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost RM3.7m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of RM16m and a profit of RM1.6m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Euro Holdings Berhad 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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