These 4 Measures Indicate That Deleum Berhad (KLSE:DELEUM) Is Using Debt Safely

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Deleum Berhad (KLSE:DELEUM) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Deleum Berhad

What Is Deleum Berhad's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Deleum Berhad had debt of RM72.9m, up from RM61.4m in one year. But on the other hand it also has RM214.3m in cash, leading to a RM141.4m net cash position.

How Strong Is Deleum Berhad's Balance Sheet?

We can see from the most recent balance sheet that Deleum Berhad had liabilities of RM240.2m falling due within a year, and liabilities of RM40.4m due beyond that. Offsetting these obligations, it had cash of RM214.3m as well as receivables valued at RM167.5m due within 12 months. So it can boast RM101.1m more liquid assets than total liabilities.

This excess liquidity is a great indication that Deleum Berhad's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Deleum Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Deleum Berhad has increased its EBIT by 8.7% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Deleum Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Deleum 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. Over the last three years, Deleum Berhad actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Deleum Berhad has RM141.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM124m, being 106% of its EBIT. So is Deleum Berhad's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with Deleum Berhad (including 1 which doesn't sit too well with us) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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