Is Karex Berhad (KLSE:KAREX) 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. We note that Karex Berhad (KLSE:KAREX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Karex Berhad

How Much Debt Does Karex Berhad Carry?

As you can see below, at the end of September 2020, Karex Berhad had RM35.7m of debt, up from RM31.3m a year ago. Click the image for more detail. But on the other hand it also has RM43.6m in cash, leading to a RM7.91m net cash position.

How Healthy Is Karex Berhad's Balance Sheet?

We can see from the most recent balance sheet that Karex Berhad had liabilities of RM124.2m falling due within a year, and liabilities of RM27.9m due beyond that. On the other hand, it had cash of RM43.6m and RM108.7m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Karex Berhad's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the RM795.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Karex Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Karex Berhad grew its EBIT by 611% over twelve months. 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 Karex 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 Karex 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 three years, Karex 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Karex Berhad has RM7.91m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 611% over the last year. So we are not troubled with Karex Berhad's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Karex Berhad that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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