Fraser & Neave Holdings Bhd (KLSE:F&N) Seems To Use Debt Rather Sparingly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Fraser & Neave Holdings Bhd (KLSE:F&N) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Fraser & Neave Holdings Bhd

What Is Fraser & Neave Holdings Bhd's Debt?

As you can see below, Fraser & Neave Holdings Bhd had RM80.1m of debt at March 2021, down from RM106.7m a year prior. However, it does have RM658.9m in cash offsetting this, leading to net cash of RM578.8m.

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

According to the last reported balance sheet, Fraser & Neave Holdings Bhd had liabilities of RM786.2m due within 12 months, and liabilities of RM128.3m due beyond 12 months. Offsetting this, it had RM658.9m in cash and RM664.9m in receivables that were due within 12 months. So it can boast RM409.2m more liquid assets than total liabilities.

This surplus suggests that Fraser & Neave Holdings Bhd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Fraser & Neave Holdings Bhd has more cash than debt is arguably a good indication that it can manage its debt safely.

While Fraser & Neave Holdings Bhd doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Fraser & Neave Holdings Bhd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Fraser & Neave Holdings Bhd recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Fraser & Neave Holdings Bhd has net cash of RM578.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in RM611m. So we don't think Fraser & Neave Holdings Bhd's use of debt is risky. 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. We've identified 1 warning sign with Fraser & Neave Holdings Bhd , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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