Is Harn Len Corporation Bhd (KLSE:HARNLEN) Using Too Much 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.' 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. As with many other companies Harn Len Corporation Bhd (KLSE:HARNLEN) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Harn Len Corporation Bhd

How Much Debt Does Harn Len Corporation Bhd Carry?

As you can see below, Harn Len Corporation Bhd had RM71.8m of debt at September 2020, down from RM100.0m a year prior. But on the other hand it also has RM91.2m in cash, leading to a RM19.4m net cash position.

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

The latest balance sheet data shows that Harn Len Corporation Bhd had liabilities of RM153.7m due within a year, and liabilities of RM82.8m falling due after that. Offsetting these obligations, it had cash of RM91.2m as well as receivables valued at RM48.0m due within 12 months. So it has liabilities totalling RM97.3m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RM117.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Harn Len Corporation Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Harn Len Corporation Bhd made a loss at the EBIT level, last year, it was also good to see that it generated RM115m in EBIT over 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 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, a company can only pay off debt with cold hard cash, not accounting profits. Harn Len Corporation Bhd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Harn Len Corporation Bhd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While Harn Len Corporation Bhd does have more liabilities than liquid assets, it also has net cash of RM19.4m. So although we see some areas for improvement, we're not too worried about Harn Len Corporation Bhd's balance sheet. 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. Case in point: We've spotted 3 warning signs for Harn Len Corporation Bhd you should be aware of, and 1 of them is a bit concerning.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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