We Think Cepatwawasan Group Berhad (KLSE:CEPAT) Can Stay On Top Of Its 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. We can see that Cepatwawasan Group Berhad (KLSE:CEPAT) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Cepatwawasan Group Berhad

What Is Cepatwawasan Group Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Cepatwawasan Group Berhad had debt of RM102.4m at the end of September 2020, a reduction from RM112.7m over a year. However, because it has a cash reserve of RM37.5m, its net debt is less, at about RM65.0m.

How Strong Is Cepatwawasan Group Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cepatwawasan Group Berhad had liabilities of RM86.0m due within 12 months and liabilities of RM69.2m due beyond that. Offsetting these obligations, it had cash of RM37.5m as well as receivables valued at RM16.6m due within 12 months. So its liabilities total RM101.2m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Cepatwawasan Group Berhad has a market capitalization of RM199.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cepatwawasan Group Berhad has a debt to EBITDA ratio of 2.5, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Pleasingly, Cepatwawasan Group Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 278% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cepatwawasan Group 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Cepatwawasan Group 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

Cepatwawasan Group Berhad's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Cepatwawasan Group Berhad's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Cepatwawasan Group Berhad (of which 1 is a bit unpleasant!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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