We Think Greenyield Berhad (KLSE:GREENYB) Can Stay On Top Of Its Debt

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. Importantly, Greenyield Berhad (KLSE:GREENYB) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Greenyield Berhad

What Is Greenyield Berhad's Net Debt?

As you can see below, Greenyield Berhad had RM13.6m of debt at December 2020, down from RM17.3m a year prior. However, it does have RM12.2m in cash offsetting this, leading to net debt of about RM1.34m.

How Strong Is Greenyield Berhad's Balance Sheet?

According to the last reported balance sheet, Greenyield Berhad had liabilities of RM6.22m due within 12 months, and liabilities of RM14.8m due beyond 12 months. On the other hand, it had cash of RM12.2m and RM6.50m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM2.23m.

Given Greenyield Berhad has a market capitalization of RM75.1m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Greenyield Berhad's net debt is only 0.14 times its EBITDA. And its EBIT easily covers its interest expense, being 17.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although Greenyield Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM7.3m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Greenyield Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Greenyield Berhad reported free cash flow worth 9.8% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that Greenyield Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Greenyield Berhad can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Greenyield Berhad that you should be aware of.

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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