These 4 Measures Indicate That Hartalega Holdings Berhad (KLSE:HARTA) Is Using Debt Safely

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 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 Hartalega Holdings Berhad (KLSE:HARTA) 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?

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Hartalega Holdings Berhad

How Much Debt Does Hartalega Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that Hartalega Holdings Berhad had debt of RM238.8m at the end of March 2022, a reduction from RM343.1m over a year. But on the other hand it also has RM2.38b in cash, leading to a RM2.14b net cash position.

How Healthy Is Hartalega Holdings Berhad's Balance Sheet?

According to the last reported balance sheet, Hartalega Holdings Berhad had liabilities of RM816.7m due within 12 months, and liabilities of RM385.7m due beyond 12 months. Offsetting these obligations, it had cash of RM2.38b as well as receivables valued at RM420.9m due within 12 months. So it actually has RM1.60b more liquid assets than total liabilities.

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

Another good sign is that Hartalega Holdings Berhad has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hartalega Holdings Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hartalega Holdings Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Hartalega Holdings Berhad recorded free cash flow worth 67% 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Hartalega Holdings Berhad has net cash of RM2.14b, as well as more liquid assets than liabilities. And we liked the look of last year's 22% year-on-year EBIT growth. So is Hartalega Holdings 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Hartalega Holdings Berhad (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.