Signature International Berhad (KLSE:SIGN) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Signature International Berhad (KLSE:SIGN) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for Signature International Berhad

What Is Signature International Berhad's Debt?

The image below, which you can click on for greater detail, shows that Signature International Berhad had debt of RM36.8m at the end of June 2021, a reduction from RM41.9m over a year. However, it does have RM89.6m in cash offsetting this, leading to net cash of RM52.8m.

How Strong Is Signature International Berhad's Balance Sheet?

According to the last reported balance sheet, Signature International Berhad had liabilities of RM71.5m due within 12 months, and liabilities of RM34.2m due beyond 12 months. On the other hand, it had cash of RM89.6m and RM60.4m worth of receivables due within a year. So it can boast RM44.3m more liquid assets than total liabilities.

This surplus suggests that Signature International Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Signature International Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Signature International Berhad turned things around in the last 12 months, delivering and EBIT of RM19m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Signature International Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Signature International 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. Over the last year, Signature International Berhad reported free cash flow worth 9.3% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Signature International Berhad has RM52.8m in net cash and a decent-looking balance sheet. So we are not troubled with Signature International Berhad's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Signature International Berhad 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.

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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