Here's Why Emico Holdings Berhad (KLSE:EMICO) Can Afford Some Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Emico Holdings Berhad (KLSE:EMICO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Emico Holdings Berhad

What Is Emico Holdings Berhad's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Emico Holdings Berhad had debt of RM9.24m, up from RM7.41m in one year. On the flip side, it has RM2.14m in cash leading to net debt of about RM7.10m.

A Look At Emico Holdings Berhad's Liabilities

We can see from the most recent balance sheet that Emico Holdings Berhad had liabilities of RM15.2m falling due within a year, and liabilities of RM7.71m due beyond that. Offsetting this, it had RM2.14m in cash and RM8.64m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM12.1m.

This deficit isn't so bad because Emico Holdings Berhad is worth RM35.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Emico 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.

Over 12 months, Emico Holdings Berhad made a loss at the EBIT level, and saw its revenue drop to RM34m, which is a fall of 12%. We would much prefer see growth.

Caveat Emptor

Not only did Emico Holdings Berhad's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost RM953k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through RM2.2m of cash over the last year. So in short it's a really risky stock. 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. Be aware that Emico Holdings Berhad is showing 3 warning signs in our investment analysis , and 2 of those are concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.