We Think TMC Life Sciences Berhad (KLSE:TMCLIFE) Can Stay On Top Of Its 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.' 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. We can see that TMC Life Sciences Berhad (KLSE:TMCLIFE) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for TMC Life Sciences Berhad

What Is TMC Life Sciences Berhad's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 TMC Life Sciences Berhad had debt of RM203.8m, up from RM164.9m in one year. However, because it has a cash reserve of RM143.1m, its net debt is less, at about RM60.6m.

How Healthy Is TMC Life Sciences Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TMC Life Sciences Berhad had liabilities of RM90.3m due within 12 months and liabilities of RM215.2m due beyond that. Offsetting these obligations, it had cash of RM143.1m as well as receivables valued at RM48.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM113.9m.

Of course, TMC Life Sciences Berhad has a market capitalization of RM958.0m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

TMC Life Sciences Berhad has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 315 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, TMC Life Sciences Berhad grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since TMC Life Sciences 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, TMC Life Sciences Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

The good news is that TMC Life Sciences Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. We would also note that Healthcare industry companies like TMC Life Sciences Berhad commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that TMC Life Sciences Berhad can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for TMC Life Sciences Berhad you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.