Is Hartalega Holdings Berhad (KLSE:HARTA) A Risky Investment?

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. As with many other companies Hartalega Holdings Berhad (KLSE:HARTA) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hartalega Holdings Berhad

What Is Hartalega Holdings Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Hartalega Holdings Berhad had RM302.5m of debt in September 2021, down from RM388.2m, one year before. However, its balance sheet shows it holds RM5.01b in cash, so it actually has RM4.71b net cash.

How Healthy Is Hartalega Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Hartalega Holdings Berhad had liabilities of RM1.89b due within a year, and liabilities of RM394.7m falling due after that. On the other hand, it had cash of RM5.01b and RM789.3m worth of receivables due within a year. So it can boast RM3.51b more liquid assets than total liabilities.

This excess liquidity suggests that Hartalega Holdings Berhad is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Hartalega Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Hartalega Holdings Berhad grew its EBIT by 450% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hartalega Holdings Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hartalega Holdings 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. Over the most recent three years, Hartalega Holdings Berhad recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Hartalega Holdings Berhad has net cash of RM4.71b, as well as more liquid assets than liabilities. And we liked the look of last year's 450% year-on-year EBIT growth. The bottom line is that we do not find Hartalega Holdings Berhad's debt levels at all concerning. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hartalega Holdings Berhad you should know about.

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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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.