Kretam Holdings Berhad (KLSE:KRETAM) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Kretam Holdings Berhad (KLSE:KRETAM) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kretam Holdings Berhad

How Much Debt Does Kretam Holdings Berhad Carry?

As you can see below, Kretam Holdings Berhad had RM100.5m of debt at June 2023, down from RM116.7m a year prior. However, its balance sheet shows it holds RM165.9m in cash, so it actually has RM65.4m net cash.

How Healthy Is Kretam Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Kretam Holdings Berhad had liabilities of RM142.6m due within a year, and liabilities of RM114.1m falling due after that. Offsetting these obligations, it had cash of RM165.9m as well as receivables valued at RM97.4m due within 12 months. So it can boast RM6.67m more liquid assets than total liabilities.

This state of affairs indicates that Kretam Holdings Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM1.49b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Kretam Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Kretam Holdings Berhad's saving grace is its low debt levels, because its EBIT has tanked 79% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kretam Holdings Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kretam Holdings Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Kretam Holdings Berhad recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Kretam Holdings Berhad has RM65.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Kretam Holdings Berhad's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Kretam Holdings Berhad you should know about.

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. 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.