SEG International Bhd (KLSE:SEG) Seems To Use Debt Quite Sensibly

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 SEG International Bhd (KLSE:SEG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for SEG International Bhd

What Is SEG International Bhd's Debt?

As you can see below, at the end of September 2020, SEG International Bhd had RM35.1m of debt, up from RM30.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds RM84.7m in cash, so it actually has RM49.6m net cash.

How Healthy Is SEG International Bhd's Balance Sheet?

We can see from the most recent balance sheet that SEG International Bhd had liabilities of RM119.6m falling due within a year, and liabilities of RM139.6m due beyond that. On the other hand, it had cash of RM84.7m and RM30.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM143.5m.

Given SEG International Bhd has a market capitalization of RM784.5m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, SEG International Bhd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, SEG International Bhd saw its EBIT drop by 3.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is SEG International Bhd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While SEG International Bhd 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, SEG International Bhd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While SEG International Bhd does have more liabilities than liquid assets, it also has net cash of RM49.6m. And it impressed us with free cash flow of RM67m, being 104% of its EBIT. So we don't have any problem with SEG International Bhd's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with SEG International Bhd .

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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