Is Teo Seng Capital Berhad (KLSE:TEOSENG) A Risky Investment?

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. Importantly, Teo Seng Capital Berhad (KLSE:TEOSENG) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Teo Seng Capital Berhad

How Much Debt Does Teo Seng Capital Berhad Carry?

The image below, which you can click on for greater detail, shows that Teo Seng Capital Berhad had debt of RM173.3m at the end of June 2023, a reduction from RM202.2m over a year. However, it also had RM45.4m in cash, and so its net debt is RM127.9m.

How Strong Is Teo Seng Capital Berhad's Balance Sheet?

We can see from the most recent balance sheet that Teo Seng Capital Berhad had liabilities of RM186.9m falling due within a year, and liabilities of RM86.9m due beyond that. Offsetting these obligations, it had cash of RM45.4m as well as receivables valued at RM75.4m due within 12 months. So it has liabilities totalling RM153.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Teo Seng Capital Berhad is worth RM334.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

With net debt sitting at just 1.5 times EBITDA, Teo Seng Capital Berhad is arguably pretty conservatively geared. And it boasts interest cover of 8.6 times, which is more than adequate. Better yet, Teo Seng Capital Berhad grew its EBIT by 228% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Teo Seng Capital Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent two years, Teo Seng Capital Berhad recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Teo Seng Capital Berhad's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like Teo Seng Capital Berhad is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Teo Seng Capital Berhad has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.