Is Sinmah Capital Berhad (KLSE:SMCAP) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Sinmah Capital Berhad (KLSE:SMCAP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Sinmah Capital Berhad

What Is Sinmah Capital Berhad's Net Debt?

As you can see below, at the end of September 2020, Sinmah Capital Berhad had RM95.0m of debt, up from RM66.2m a year ago. Click the image for more detail. However, because it has a cash reserve of RM38.6m, its net debt is less, at about RM56.4m.

How Healthy Is Sinmah Capital Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sinmah Capital Berhad had liabilities of RM63.8m due within 12 months and liabilities of RM57.3m due beyond that. Offsetting this, it had RM38.6m in cash and RM55.6m in receivables that were due within 12 months. So its liabilities total RM26.8m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Sinmah Capital Berhad has a market capitalization of RM130.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sinmah Capital Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (20.5), and fairly weak interest coverage, since EBIT is just 0.34 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for Sinmah Capital Berhad is that it turned last year's EBIT loss into a gain of RM1.7m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sinmah Capital Berhad will need earnings to service that debt. 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, 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. During the last year, Sinmah Capital Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Sinmah Capital Berhad's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, we think it's fair to say that Sinmah Capital Berhad has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 4 warning signs with Sinmah Capital Berhad (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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