Is Tex Cycle Technology (M) Berhad (KLSE:TEXCYCL) Using Too Much Debt?

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 Tex Cycle Technology (M) Berhad (KLSE:TEXCYCL) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Tex Cycle Technology (M) Berhad

What Is Tex Cycle Technology (M) Berhad's Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Tex Cycle Technology (M) Berhad had debt of RM28.0m, up from RM6.10m in one year. However, because it has a cash reserve of RM22.5m, its net debt is less, at about RM5.52m.

How Strong Is Tex Cycle Technology (M) Berhad's Balance Sheet?

According to the last reported balance sheet, Tex Cycle Technology (M) Berhad had liabilities of RM7.61m due within 12 months, and liabilities of RM28.6m due beyond 12 months. Offsetting this, it had RM22.5m in cash and RM17.5m in receivables that were due within 12 months. So it actually has RM3.82m more liquid assets than total liabilities.

This surplus suggests that Tex Cycle Technology (M) Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

Tex Cycle Technology (M) Berhad's net debt is only 0.49 times its EBITDA. And its EBIT easily covers its interest expense, being 26.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Tex Cycle Technology (M) Berhad's EBIT dived 11%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tex Cycle Technology (M) Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Tex Cycle Technology (M) Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Tex Cycle Technology (M) Berhad is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Tex Cycle Technology (M) Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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 3 warning signs for Tex Cycle Technology (M) Berhad (2 make us uncomfortable!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.