Wah Seong Corporation Berhad (KLSE:WASEONG) Takes On Some Risk With Its Use Of 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. We note that Wah Seong Corporation Berhad (KLSE:WASEONG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Wah Seong Corporation Berhad

How Much Debt Does Wah Seong Corporation Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that Wah Seong Corporation Berhad had RM798.7m of debt in June 2021, down from RM980.2m, one year before. However, it also had RM200.1m in cash, and so its net debt is RM598.6m.

How Healthy Is Wah Seong Corporation Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wah Seong Corporation Berhad had liabilities of RM1.14b due within 12 months and liabilities of RM346.1m due beyond that. Offsetting these obligations, it had cash of RM200.1m as well as receivables valued at RM582.4m due within 12 months. So its liabilities total RM701.6m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's RM499.4m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Wah Seong Corporation Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (6.5), and fairly weak interest coverage, since EBIT is just 0.76 times the interest expense. The debt burden here is substantial. The good news is that Wah Seong Corporation Berhad grew its EBIT a smooth 85% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Wah Seong Corporation 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Wah Seong Corporation 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

We feel some trepidation about Wah Seong Corporation Berhad's difficulty interest cover, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Wah Seong Corporation 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Wah Seong Corporation Berhad 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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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.
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