Is Esthetics International Group Berhad (KLSE:EIG) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Esthetics International Group Berhad (KLSE:EIG) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Esthetics International Group Berhad

What Is Esthetics International Group Berhad's Debt?

As you can see below, Esthetics International Group Berhad had RM21.3m of debt at September 2020, down from RM22.3m a year prior. However, it does have RM59.6m in cash offsetting this, leading to net cash of RM38.3m.

How Healthy Is Esthetics International Group Berhad's Balance Sheet?

We can see from the most recent balance sheet that Esthetics International Group Berhad had liabilities of RM65.8m falling due within a year, and liabilities of RM27.7m due beyond that. Offsetting these obligations, it had cash of RM59.6m as well as receivables valued at RM19.6m due within 12 months. So its liabilities total RM14.4m more than the combination of its cash and short-term receivables.

Given Esthetics International Group Berhad has a market capitalization of RM102.0m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Esthetics International Group Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Esthetics International Group Berhad's load is not too heavy, because its EBIT was down 88% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Esthetics International Group Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Esthetics International Group 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. Happily for any shareholders, Esthetics International Group Berhad actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Esthetics International Group Berhad does have more liabilities than liquid assets, it also has net cash of RM38.3m. And it impressed us with free cash flow of RM19m, being 271% of its EBIT. So we are not troubled with Esthetics International Group Berhad's debt use. 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, we've discovered 4 warning signs for Esthetics International Group Berhad (1 is potentially serious!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.
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