Does Kretam Holdings Berhad (KLSE:KRETAM) Have A Healthy Balance Sheet?

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.' 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, Kretam Holdings Berhad (KLSE:KRETAM) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kretam Holdings Berhad

What Is Kretam Holdings Berhad's Debt?

As you can see below, Kretam Holdings Berhad had RM34.2m of debt at September 2020, down from RM84.3m a year prior. On the flip side, it has RM32.2m in cash leading to net debt of about RM2.03m.

How Strong Is Kretam Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Kretam Holdings Berhad had liabilities of RM80.3m due within a year, and liabilities of RM79.2m falling due after that. Offsetting these obligations, it had cash of RM32.2m as well as receivables valued at RM46.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM80.9m.

Of course, Kretam Holdings Berhad has a market capitalization of RM1.36b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Kretam Holdings Berhad has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

With debt at a measly 0.023 times EBITDA and EBIT covering interest a whopping 17.2 times, it's clear that Kretam Holdings Berhad is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. It was also good to see that despite losing money on the EBIT line last year, Kretam Holdings Berhad turned things around in the last 12 months, delivering and EBIT of RM44m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kretam Holdings Berhad'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, 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, Kretam Holdings Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Kretam Holdings Berhad's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Kretam Holdings Berhad seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Kretam Holdings Berhad you should know about.

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. 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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