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 Poh Huat Resources Holdings Berhad (KLSE:POHUAT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Poh Huat Resources Holdings Berhad Carry?
You can click the graphic below for the historical numbers, but it shows that as of January 2021 Poh Huat Resources Holdings Berhad had RM30.3m of debt, an increase on RM17.9m, over one year. However, it does have RM169.8m in cash offsetting this, leading to net cash of RM139.4m.
How Healthy Is Poh Huat Resources Holdings Berhad's Balance Sheet?
The latest balance sheet data shows that Poh Huat Resources Holdings Berhad had liabilities of RM120.5m due within a year, and liabilities of RM18.9m falling due after that. Offsetting this, it had RM169.8m in cash and RM66.6m in receivables that were due within 12 months. So it actually has RM97.0m more liquid assets than total liabilities.
This surplus suggests that Poh Huat Resources Holdings Berhad is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Poh Huat Resources Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Poh Huat Resources Holdings Berhad grew its EBIT by 5.3% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Poh Huat Resources Holdings Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Poh Huat Resources Holdings 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. Looking at the most recent three years, Poh Huat Resources Holdings Berhad recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Poh Huat Resources Holdings Berhad has net cash of RM139.4m, as well as more liquid assets than liabilities. And it also grew its EBIT by 5.3% over the last year. So we don't think Poh Huat Resources Holdings 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. Case in point: We've spotted 4 warning signs for Poh Huat Resources Holdings Berhad you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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