Here's Why DPS Resources Berhad (KLSE:DPS) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, DPS Resources Berhad (KLSE:DPS) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for DPS Resources Berhad

How Much Debt Does DPS Resources Berhad Carry?

As you can see below, DPS Resources Berhad had RM9.54m of debt at June 2021, down from RM10.4m a year prior. However, it does have RM6.08m in cash offsetting this, leading to net debt of about RM3.46m.

How Healthy Is DPS Resources Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DPS Resources Berhad had liabilities of RM24.9m due within 12 months and liabilities of RM13.1m due beyond that. Offsetting these obligations, it had cash of RM6.08m as well as receivables valued at RM54.2m due within 12 months. So it actually has RM22.3m more liquid assets than total liabilities.

This surplus suggests that DPS Resources Berhad is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

DPS Resources Berhad's net debt is only 0.19 times its EBITDA. And its EBIT easily covers its interest expense, being 34.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, DPS Resources Berhad grew its EBIT by 5.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since DPS Resources 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last two years, DPS Resources Berhad actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

The good news is that DPS Resources Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that DPS Resources Berhad can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For instance, we've identified 3 warning signs for DPS Resources Berhad that you should be aware of.

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.
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