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 note that Tex Cycle Technology (M) Berhad (KLSE:TEXCYCL) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Tex Cycle Technology (M) Berhad Carry?
The image below, which you can click on for greater detail, shows that Tex Cycle Technology (M) Berhad had debt of RM6.85m at the end of March 2021, a reduction from RM10.4m over a year. But it also has RM20.7m in cash to offset that, meaning it has RM13.9m net cash.
A Look At Tex Cycle Technology (M) Berhad's Liabilities
The latest balance sheet data shows that Tex Cycle Technology (M) Berhad had liabilities of RM3.68m due within a year, and liabilities of RM8.27m falling due after that. On the other hand, it had cash of RM20.7m and RM12.2m worth of receivables due within a year. So it actually has RM21.0m more liquid assets than total liabilities.
This surplus suggests that Tex Cycle Technology (M) Berhad is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Tex Cycle Technology (M) 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 Tex Cycle Technology (M) Berhad has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tex Cycle Technology (M) Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tex Cycle Technology (M) Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Tex Cycle Technology (M) Berhad produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Tex Cycle Technology (M) Berhad has net cash of RM13.9m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 30% over the last year. So we don't think Tex Cycle Technology (M) Berhad's use of debt is risky. 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. For example, we've discovered 2 warning signs for Tex Cycle Technology (M) Berhad (1 shouldn't be ignored!) that you should be aware of before investing here.
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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