Here's Why Straits Inter Logistics Berhad (KLSE:STRAITS) Has A Meaningful Debt Burden

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Straits Inter Logistics Berhad (KLSE:STRAITS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. 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 Straits Inter Logistics Berhad

What Is Straits Inter Logistics Berhad's Debt?

As you can see below, at the end of June 2020, Straits Inter Logistics Berhad had RM56.6m of debt, up from RM35.7m a year ago. Click the image for more detail. On the flip side, it has RM6.66m in cash leading to net debt of about RM50.0m.

How Strong Is Straits Inter Logistics Berhad's Balance Sheet?

The latest balance sheet data shows that Straits Inter Logistics Berhad had liabilities of RM73.3m due within a year, and liabilities of RM24.2m falling due after that. Offsetting these obligations, it had cash of RM6.66m as well as receivables valued at RM63.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM27.7m.

While this might seem like a lot, it is not so bad since Straits Inter Logistics Berhad has a market capitalization of RM117.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Straits Inter Logistics Berhad's net debt to EBITDA ratio of 2.8, we think its super-low interest cover of 2.5 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, one redeeming factor is that Straits Inter Logistics Berhad grew its EBIT at 13% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Straits Inter Logistics Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Straits Inter Logistics Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Straits Inter Logistics Berhad's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to grow its EBIT isn't too shabby at all. Taking the abovementioned factors together we do think Straits Inter Logistics Berhad's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 Straits Inter Logistics Berhad is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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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