Is Hiap Huat Holdings Berhad (KLSE:HHHCORP) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Hiap Huat Holdings Berhad (KLSE:HHHCORP) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Hiap Huat Holdings Berhad

How Much Debt Does Hiap Huat Holdings Berhad Carry?

As you can see below, Hiap Huat Holdings Berhad had RM12.7m of debt at March 2021, down from RM13.9m a year prior. However, because it has a cash reserve of RM12.6m, its net debt is less, at about RM45.0k.

How Healthy Is Hiap Huat Holdings Berhad's Balance Sheet?

According to the last reported balance sheet, Hiap Huat Holdings Berhad had liabilities of RM8.03m due within 12 months, and liabilities of RM18.7m due beyond 12 months. Offsetting this, it had RM12.6m in cash and RM8.51m in receivables that were due within 12 months. So it has liabilities totalling RM5.64m more than its cash and near-term receivables, combined.

Of course, Hiap Huat Holdings Berhad has a market capitalization of RM47.7m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, Hiap Huat Holdings Berhad has a very light debt load indeed.

Importantly, Hiap Huat Holdings Berhad's EBIT fell a jaw-dropping 93% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hiap Huat Holdings 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. Happily for any shareholders, Hiap Huat Holdings 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.

Our View

Hiap Huat Holdings Berhad's EBIT growth rate was a real negative on this analysis, as was its interest cover. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about Hiap Huat Holdings Berhad's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hiap Huat Holdings Berhad is showing 2 warning signs in our investment analysis , you should know about...

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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