Is Hwa Tai Industries Berhad (KLSE:HWATAI) 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. We note that Hwa Tai Industries Berhad (KLSE:HWATAI) does have debt on its balance sheet. 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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Hwa Tai Industries Berhad

How Much Debt Does Hwa Tai Industries Berhad Carry?

The image below, which you can click on for greater detail, shows that at March 2022 Hwa Tai Industries Berhad had debt of RM25.1m, up from RM20.5m in one year. On the flip side, it has RM8.32m in cash leading to net debt of about RM16.7m.

How Strong Is Hwa Tai Industries Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hwa Tai Industries Berhad had liabilities of RM46.8m due within 12 months and liabilities of RM1.53m due beyond that. Offsetting this, it had RM8.32m in cash and RM24.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM15.5m.

While this might seem like a lot, it is not so bad since Hwa Tai Industries Berhad has a market capitalization of RM49.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hwa Tai Industries Berhad will need earnings to service that debt. 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.

In the last year Hwa Tai Industries Berhad had a loss before interest and tax, and actually shrunk its revenue by 7.2%, to RM72m. That's not what we would hope to see.

Caveat Emptor

Importantly, Hwa Tai Industries Berhad had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost RM2.8m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled RM4.5m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Hwa Tai Industries Berhad (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.