Here's Why Teck Guan Perdana Berhad (KLSE:TECGUAN) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Teck Guan Perdana Berhad (KLSE:TECGUAN) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Teck Guan Perdana Berhad

How Much Debt Does Teck Guan Perdana Berhad Carry?

As you can see below, Teck Guan Perdana Berhad had RM69.0m of debt at July 2022, down from RM84.8m a year prior. However, it does have RM47.5m in cash offsetting this, leading to net debt of about RM21.4m.

A Look At Teck Guan Perdana Berhad's Liabilities

The latest balance sheet data shows that Teck Guan Perdana Berhad had liabilities of RM131.9m due within a year, and liabilities of RM23.6m falling due after that. On the other hand, it had cash of RM47.5m and RM67.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM41.0m.

This is a mountain of leverage relative to its market capitalization of RM58.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Teck Guan Perdana Berhad's net debt is only 0.54 times its EBITDA. And its EBIT covers its interest expense a whopping 17.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Teck Guan Perdana Berhad grew its EBIT by 311% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Teck Guan Perdana Berhad's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Teck Guan Perdana Berhad created free cash flow amounting to 4.3% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Teck Guan Perdana Berhad's interest cover was a real positive on this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Teck Guan Perdana Berhad is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Teck Guan Perdana Berhad that you should be aware of.

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.