Deleum Berhad (KLSE:DELEUM) Seems To Use Debt Rather Sparingly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Deleum Berhad (KLSE:DELEUM) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for Deleum Berhad

How Much Debt Does Deleum Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that Deleum Berhad had RM76.1m of debt in December 2020, down from RM87.2m, one year before. However, it does have RM232.6m in cash offsetting this, leading to net cash of RM156.6m.

How Strong Is Deleum Berhad's Balance Sheet?

We can see from the most recent balance sheet that Deleum Berhad had liabilities of RM236.6m falling due within a year, and liabilities of RM41.5m due beyond that. Offsetting these obligations, it had cash of RM232.6m as well as receivables valued at RM163.4m due within 12 months. So it can boast RM117.8m more liquid assets than total liabilities.

This surplus liquidity suggests that Deleum Berhad's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Deleum Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Deleum Berhad grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Deleum Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Deleum 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. During the last three years, Deleum Berhad generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Deleum Berhad has net cash of RM156.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM71m, being 86% of its EBIT. When it comes to Deleum Berhad's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. Be aware that Deleum Berhad is showing 5 warning signs in our investment analysis , you should know about...

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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