These 4 Measures Indicate That Poh Huat Resources Holdings Berhad (KLSE:POHUAT) Is Using Debt Reasonably Well

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.' 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Poh Huat Resources Holdings Berhad

How Much Debt Does Poh Huat Resources Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that at July 2020 Poh Huat Resources Holdings Berhad had debt of RM30.6m, up from RM15.7m in one year. However, its balance sheet shows it holds RM143.9m in cash, so it actually has RM113.2m net cash.

A Look At Poh Huat Resources Holdings Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Poh Huat Resources Holdings Berhad had liabilities of RM114.2m due within 12 months and liabilities of RM6.35m due beyond that. Offsetting these obligations, it had cash of RM143.9m as well as receivables valued at RM53.3m due within 12 months. So it can boast RM76.6m more liquid assets than total liabilities.

It's good to see that Poh Huat Resources Holdings Berhad has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble 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.

On the other hand, Poh Huat Resources Holdings Berhad's EBIT dived 20%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Poh Huat Resources Holdings Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Poh Huat Resources Holdings Berhad's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Poh Huat Resources Holdings Berhad has net cash of RM113.2m, as well as more liquid assets than liabilities. So we don't have any problem with Poh Huat Resources Holdings Berhad's use of debt. 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. Take risks, for example - Poh Huat Resources Holdings Berhad has 2 warning signs we think you should be aware of.

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.

If you’re looking to trade Poh Huat Resources Holdings Berhad, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.