Dayang Enterprise Holdings Bhd (KLSE:DAYANG) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Dayang Enterprise Holdings Bhd (KLSE:DAYANG) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 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, 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.

View our latest analysis for Dayang Enterprise Holdings Bhd

What Is Dayang Enterprise Holdings Bhd's Net Debt?

The image below, which you can click on for greater detail, shows that Dayang Enterprise Holdings Bhd had debt of RM690.2m at the end of March 2021, a reduction from RM807.7m over a year. However, it also had RM577.9m in cash, and so its net debt is RM112.3m.

A Look At Dayang Enterprise Holdings Bhd's Liabilities

We can see from the most recent balance sheet that Dayang Enterprise Holdings Bhd had liabilities of RM322.7m falling due within a year, and liabilities of RM608.1m due beyond that. Offsetting this, it had RM577.9m in cash and RM256.6m in receivables that were due within 12 months. So its liabilities total RM96.3m more than the combination of its cash and short-term receivables.

Since publicly traded Dayang Enterprise Holdings Bhd shares are worth a total of RM1.63b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.65 and interest cover of 2.5 times, it seems to us that Dayang Enterprise Holdings Bhd is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, Dayang Enterprise Holdings Bhd's EBIT fell a jaw-dropping 83% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Dayang Enterprise Holdings Bhd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Dayang Enterprise Holdings 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.

Our View

Dayang Enterprise Holdings Bhd's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Considering this range of data points, we think Dayang Enterprise Holdings Bhd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 - Dayang Enterprise Holdings Bhd has 2 warning signs we think you should be aware of.

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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