Sinmah Capital Berhad (KLSE:SMCAP) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Sinmah Capital Berhad (KLSE:SMCAP) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Sinmah Capital Berhad

How Much Debt Does Sinmah Capital Berhad Carry?

The image below, which you can click on for greater detail, shows that Sinmah Capital Berhad had debt of RM15.9m at the end of September 2022, a reduction from RM75.5m over a year. However, it does have RM14.3m in cash offsetting this, leading to net debt of about RM1.66m.

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 RM56.0m due within 12 months and liabilities of RM8.25m due beyond that. On the other hand, it had cash of RM14.3m and RM54.0m worth of receivables due within a year. So it can boast RM4.03m more liquid assets than total liabilities.

This surplus suggests that Sinmah Capital Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sinmah Capital Berhad has a very low debt to EBITDA ratio of 0.27 so it is strange to see weak interest coverage, with last year's EBIT being only 0.65 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. It is well worth noting that Sinmah Capital Berhad's EBIT shot up like bamboo after rain, gaining 80% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sinmah Capital 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Sinmah Capital Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We weren't impressed with Sinmah Capital Berhad's interest cover, and its conversion of EBIT to free cash flow made us cautious. But its EBIT growth rate was significantly redeeming. When we consider all the elements mentioned above, it seems to us that Sinmah Capital Berhad is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example Sinmah Capital Berhad has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

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.