Supermax Corporation Berhad (KLSE:SUPERMX) Could Easily Take On More Debt

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. We can see that Supermax Corporation Berhad (KLSE:SUPERMX) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that SUPERMX is potentially undervalued!

What Is Supermax Corporation Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Supermax Corporation Berhad had debt of RM232.6m at the end of June 2022, a reduction from RM257.5m over a year. However, its balance sheet shows it holds RM3.03b in cash, so it actually has RM2.80b net cash.

How Strong Is Supermax Corporation Berhad's Balance Sheet?

According to the last reported balance sheet, Supermax Corporation Berhad had liabilities of RM805.8m due within 12 months, and liabilities of RM120.7m due beyond 12 months. On the other hand, it had cash of RM3.03b and RM691.4m worth of receivables due within a year. So it actually has RM2.80b more liquid assets than total liabilities.

This excess liquidity is a great indication that Supermax Corporation Berhad's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Supermax Corporation Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Supermax Corporation Berhad if management cannot prevent a repeat of the 80% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Supermax Corporation 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Supermax Corporation 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, Supermax Corporation Berhad recorded free cash flow worth 63% 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, the bottom line is that Supermax Corporation Berhad has net cash of RM2.80b and plenty of liquid assets. So is Supermax Corporation 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. For instance, we've identified 4 warning signs for Supermax Corporation Berhad (2 are potentially serious) 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.