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 Eduspec Holdings Berhad (KLSE:EDUSPEC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Eduspec Holdings Berhad Carry?
As you can see below, Eduspec Holdings Berhad had RM25.3m of debt at August 2021, down from RM35.6m a year prior. However, it does have RM3.78m in cash offsetting this, leading to net debt of about RM21.6m.
How Strong Is Eduspec Holdings Berhad's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Eduspec Holdings Berhad had liabilities of RM35.8m due within 12 months and liabilities of RM22.3m due beyond that. Offsetting this, it had RM3.78m in cash and RM24.3m in receivables that were due within 12 months. So it has liabilities totalling RM29.9m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of RM45.7m, so it does suggest shareholders should keep an eye on Eduspec Holdings Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Eduspec Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Eduspec Holdings Berhad had a loss before interest and tax, and actually shrunk its revenue by 39%, to RM9.0m. That makes us nervous, to say the least.
While Eduspec Holdings Berhad's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping RM19m. 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. Another cause for caution is that is bled RM15m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Eduspec Holdings Berhad has 6 warning signs (and 3 which are a bit unpleasant) we think you should know about.
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.