Here's Why SMRT Holdings Berhad (KLSE:SMRT) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, SMRT Holdings Berhad (KLSE:SMRT) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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

See our latest analysis for SMRT Holdings Berhad

What Is SMRT Holdings Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 SMRT Holdings Berhad had RM31.2m of debt, an increase on RM19.5m, over one year. However, its balance sheet shows it holds RM37.3m in cash, so it actually has RM6.09m net cash.

A Look At SMRT Holdings Berhad's Liabilities

We can see from the most recent balance sheet that SMRT Holdings Berhad had liabilities of RM88.4m falling due within a year, and liabilities of RM192.3m due beyond that. On the other hand, it had cash of RM37.3m and RM99.1m worth of receivables due within a year. So it has liabilities totalling RM144.4m more than its cash and near-term receivables, combined.

This deficit isn't so bad because SMRT Holdings Berhad is worth RM391.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, SMRT Holdings Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, SMRT Holdings Berhad grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SMRT Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. SMRT Holdings 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. During the last three years, SMRT Holdings Berhad produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While SMRT Holdings Berhad does have more liabilities than liquid assets, it also has net cash of RM6.09m. And it impressed us with its EBIT growth of 75% over the last year. So we are not troubled with SMRT Holdings Berhad's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for SMRT Holdings Berhad (2 are a bit concerning!) that you should be aware of before investing here.

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.