Is Pan Malaysia Holdings Berhad (KLSE:PMHLDG) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Pan Malaysia Holdings Berhad (KLSE:PMHLDG) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Pan Malaysia Holdings Berhad

What Is Pan Malaysia Holdings Berhad's Net Debt?

As you can see below, Pan Malaysia Holdings Berhad had RM14.5m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had RM325.0k in cash, and so its net debt is RM14.2m.

A Look At Pan Malaysia Holdings Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Pan Malaysia Holdings Berhad had liabilities of RM7.60m due within 12 months and liabilities of RM13.6m due beyond that. On the other hand, it had cash of RM325.0k and RM32.9m worth of receivables due within a year. So it actually has RM12.0m more liquid assets than total liabilities.

This surplus suggests that Pan Malaysia 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.37 times and a disturbingly high net debt to EBITDA ratio of 10.8 hit our confidence in Pan Malaysia Holdings Berhad like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Pan Malaysia Holdings Berhad achieved a positive EBIT of RM304k in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Pan Malaysia Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Pan Malaysia Holdings Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Both Pan Malaysia Holdings Berhad's conversion of EBIT to free cash flow and its interest cover were discouraging. At least its level of total liabilities gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Pan Malaysia Holdings Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 5 warning signs with Pan Malaysia Holdings Berhad (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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.

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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.