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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Kretam Holdings Berhad (KLSE:KRETAM) makes use of 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kretam Holdings Berhad

What Is Kretam Holdings Berhad's Net Debt?

As you can see below, at the end of December 2021, Kretam Holdings Berhad had RM110.8m of debt, up from RM34.4m a year ago. Click the image for more detail. However, it does have RM100.9m in cash offsetting this, leading to net debt of about RM9.91m.

How Strong Is Kretam Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kretam Holdings Berhad had liabilities of RM190.5m due within 12 months and liabilities of RM97.3m due beyond that. On the other hand, it had cash of RM100.9m and RM91.8m worth of receivables due within a year. So its liabilities total RM95.1m more than the combination of its cash and short-term receivables.

Of course, Kretam Holdings Berhad has a market capitalization of RM1.45b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Kretam Holdings Berhad has a very light debt load indeed.

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.

With debt at a measly 0.049 times EBITDA and EBIT covering interest a whopping 119 times, it's clear that Kretam Holdings Berhad is not a desperate borrower. So relative to past earnings, the debt load seems trivial. Even more impressive was the fact that Kretam Holdings Berhad grew its EBIT by 201% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kretam Holdings Berhad'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last two years, Kretam Holdings Berhad's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Kretam Holdings Berhad's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Kretam Holdings Berhad you should be aware of, and 1 of them is potentially serious.

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.