These 4 Measures Indicate That Hiap Huat Holdings Berhad (KLSE:HHHCORP) Is Using Debt Extensively

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.' 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. Importantly, Hiap Huat Holdings Berhad (KLSE:HHHCORP) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hiap Huat Holdings Berhad

What Is Hiap Huat Holdings Berhad's Debt?

As you can see below, Hiap Huat Holdings Berhad had RM24.7m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had RM13.9m in cash, and so its net debt is RM10.8m.

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

The latest balance sheet data shows that Hiap Huat Holdings Berhad had liabilities of RM10.9m due within a year, and liabilities of RM64.7m falling due after that. On the other hand, it had cash of RM13.9m and RM11.7m worth of receivables due within a year. So its liabilities total RM50.0m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM53.3m, so it does suggest shareholders should keep an eye on Hiap Huat Holdings Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 0.66 times EBITDA, Hiap Huat Holdings Berhad is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.3 times the interest expense over the last year. Also good is that Hiap Huat Holdings Berhad grew its EBIT at 13% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hiap Huat 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Hiap Huat Holdings Berhad created free cash flow amounting to 6.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

While Hiap Huat Holdings Berhad's conversion of EBIT to free cash flow does give us pause, its net debt to EBITDA and EBIT growth rate suggest it can stay on top of its debt load. When we consider all the factors discussed, it seems to us that Hiap Huat Holdings Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Hiap Huat Holdings Berhad you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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