Fraser & Neave Holdings Bhd (KLSE:F&N) Has A Rock Solid Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Fraser & Neave Holdings Bhd (KLSE:F&N) does use debt in its business. But is this debt a concern to shareholders?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Fraser & Neave Holdings Bhd

How Much Debt Does Fraser & Neave Holdings Bhd Carry?

The image below, which you can click on for greater detail, shows that at December 2022 Fraser & Neave Holdings Bhd had debt of RM710.0m, up from RM1.00m in one year. However, it also had RM625.8m in cash, and so its net debt is RM84.2m.

How Healthy Is Fraser & Neave Holdings Bhd's Balance Sheet?

We can see from the most recent balance sheet that Fraser & Neave Holdings Bhd had liabilities of RM870.3m falling due within a year, and liabilities of RM880.7m due beyond that. On the other hand, it had cash of RM625.8m and RM790.6m worth of receivables due within a year. So its liabilities total RM334.6m more than the combination of its cash and short-term receivables.

Of course, Fraser & Neave Holdings Bhd has a market capitalization of RM9.54b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Fraser & Neave Holdings Bhd has a very light debt load indeed.

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.

Fraser & Neave Holdings Bhd has a low net debt to EBITDA ratio of only 0.12. And its EBIT covers its interest expense a whopping 79.4 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Fraser & Neave Holdings Bhd grew its EBIT by 38% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Fraser & Neave Holdings Bhd can strengthen its balance sheet over time. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Fraser & Neave Holdings Bhd produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Fraser & Neave Holdings Bhd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Fraser & Neave Holdings Bhd is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Fraser & Neave Holdings Bhd you should be aware of.

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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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.