Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Rex Industry Berhad (KLSE:REX) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Rex Industry Berhad's Net Debt?
The image below, which you can click on for greater detail, shows that Rex Industry Berhad had debt of RM28.7m at the end of December 2020, a reduction from RM34.4m over a year. However, it also had RM14.1m in cash, and so its net debt is RM14.6m.
How Strong Is Rex Industry Berhad's Balance Sheet?
The latest balance sheet data shows that Rex Industry Berhad had liabilities of RM52.5m due within a year, and liabilities of RM13.4m falling due after that. Offsetting these obligations, it had cash of RM14.1m as well as receivables valued at RM33.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM18.0m.
Given Rex Industry Berhad has a market capitalization of RM111.0m, 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Rex Industry 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.
In the last year Rex Industry Berhad wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to RM158m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, Rex Industry Berhad had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost RM2.6m 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. However, it doesn't help that it burned through RM3.3m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Rex Industry Berhad (at least 2 which can't be ignored) , 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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