These 4 Measures Indicate That Kretam Holdings Berhad (KLSE:KRETAM) Is Using Debt Safely

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Kretam Holdings Berhad (KLSE:KRETAM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kretam Holdings Berhad

How Much Debt Does Kretam Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that Kretam Holdings Berhad had debt of RM34.4m at the end of December 2020, a reduction from RM60.2m over a year. But it also has RM50.0m in cash to offset that, meaning it has RM15.6m net cash.

How Strong Is Kretam Holdings Berhad's Balance Sheet?

According to the last reported balance sheet, Kretam Holdings Berhad had liabilities of RM109.4m due within 12 months, and liabilities of RM79.8m due beyond 12 months. Offsetting this, it had RM50.0m in cash and RM47.0m in receivables that were due within 12 months. So it has liabilities totalling RM92.1m more than its cash and near-term receivables, combined.

Given Kretam Holdings Berhad has a market capitalization of RM1.51b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Kretam Holdings Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Kretam Holdings Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM60m in EBIT over the last twelve months. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Kretam Holdings Berhad 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. During the last year, Kretam Holdings Berhad generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Kretam Holdings Berhad has RM15.6m in net cash. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in RM57m. So is Kretam Holdings Berhad's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Kretam Holdings Berhad .

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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