We Think E.A. Technique (M) Berhad (KLSE:EATECH) Is Taking Some Risk With Its Debt

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. Importantly, E.A. Technique (M) Berhad (KLSE:EATECH) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for E.A. Technique (M) Berhad

What Is E.A. Technique (M) Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that E.A. Technique (M) Berhad had RM260.1m of debt in September 2022, down from RM274.1m, one year before. However, because it has a cash reserve of RM29.1m, its net debt is less, at about RM231.0m.

How Healthy Is E.A. Technique (M) Berhad's Balance Sheet?

According to the last reported balance sheet, E.A. Technique (M) Berhad had liabilities of RM513.6m due within 12 months, and liabilities of RM3.08m due beyond 12 months. On the other hand, it had cash of RM29.1m and RM26.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM460.7m.

This deficit casts a shadow over the RM90.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, E.A. Technique (M) Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

E.A. Technique (M) Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (5.5), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. The debt burden here is substantial. One redeeming factor for E.A. Technique (M) Berhad is that it turned last year's EBIT loss into a gain of RM14m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is E.A. Technique (M) 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, E.A. Technique (M) Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, E.A. Technique (M) Berhad's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that E.A. Technique (M) Berhad has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 3 warning signs with E.A. Technique (M) Berhad (at least 2 which are significant) , and understanding them should be part of your investment process.

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. 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.