Careplus Group Berhad (KLSE:CAREPLS) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Careplus Group Berhad (KLSE:CAREPLS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Careplus Group Berhad

What Is Careplus Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that Careplus Group Berhad had debt of RM27.6m at the end of September 2020, a reduction from RM89.7m over a year. However, its balance sheet shows it holds RM41.5m in cash, so it actually has RM14.0m net cash.

How Strong Is Careplus Group Berhad's Balance Sheet?

We can see from the most recent balance sheet that Careplus Group Berhad had liabilities of RM76.6m falling due within a year, and liabilities of RM19.1m due beyond that. Offsetting this, it had RM41.5m in cash and RM35.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM18.7m.

Having regard to Careplus Group Berhad's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the RM1.41b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Careplus Group Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Careplus Group Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM89m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Careplus Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Careplus Group Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last year, Careplus Group Berhad produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Careplus Group Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM14.0m. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in RM64m. So is Careplus Group Berhad's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with Careplus Group Berhad .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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