Harn Len Corporation Bhd (KLSE:HARNLEN) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Harn Len Corporation Bhd (KLSE:HARNLEN) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Our analysis indicates that HARNLEN is potentially undervalued!

What Is Harn Len Corporation Bhd's Debt?

You can click the graphic below for the historical numbers, but it shows that Harn Len Corporation Bhd had RM52.7m of debt in September 2022, down from RM62.9m, one year before. However, it also had RM22.4m in cash, and so its net debt is RM30.3m.

How Strong Is Harn Len Corporation Bhd's Balance Sheet?

We can see from the most recent balance sheet that Harn Len Corporation Bhd had liabilities of RM70.1m falling due within a year, and liabilities of RM56.2m due beyond that. Offsetting these obligations, it had cash of RM22.4m as well as receivables valued at RM34.8m due within 12 months. So it has liabilities totalling RM69.0m more than its cash and near-term receivables, combined.

Given Harn Len Corporation Bhd has a market capitalization of RM387.5m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Looking at its net debt to EBITDA of 0.96 and interest cover of 3.6 times, it seems to us that Harn Len Corporation Bhd is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably, Harn Len Corporation Bhd made a loss at the EBIT level, last year, but improved that to positive EBIT of RM15m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Harn Len Corporation Bhd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Harn Len Corporation Bhd recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Harn Len Corporation Bhd's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its interest cover. All these things considered, it appears that Harn Len Corporation Bhd can comfortably handle its current debt levels. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Harn Len Corporation Bhd that 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.