Here's Why Handal Energy Berhad (KLSE:HANDAL) Can Afford Some Debt

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 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, Handal Energy Berhad (KLSE:HANDAL) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Handal Energy Berhad

What Is Handal Energy Berhad's Net Debt?

As you can see below, Handal Energy Berhad had RM16.7m of debt at March 2022, down from RM21.1m a year prior. However, it also had RM791.0k in cash, and so its net debt is RM15.9m.

A Look At Handal Energy Berhad's Liabilities

We can see from the most recent balance sheet that Handal Energy Berhad had liabilities of RM47.6m falling due within a year, and liabilities of RM1.59m due beyond that. On the other hand, it had cash of RM791.0k and RM27.5m worth of receivables due within a year. So its liabilities total RM20.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM34.9m, so it does suggest shareholders should keep an eye on Handal Energy Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Handal Energy 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.

In the last year Handal Energy Berhad had a loss before interest and tax, and actually shrunk its revenue by 27%, to RM55m. That makes us nervous, to say the least.

Caveat Emptor

While Handal Energy Berhad's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping RM8.9m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of RM6.8m. So in short it's a really risky stock. 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. Case in point: We've spotted 4 warning signs for Handal Energy Berhad you should be aware of, and 3 of them make us uncomfortable.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.