Stock Analysis

These 4 Measures Indicate That Eonmetall Group Berhad (KLSE:EMETALL) Is Using Debt Extensively

KLSE:EMETALL
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Eonmetall Group Berhad (KLSE:EMETALL) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Eonmetall Group Berhad

What Is Eonmetall Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Eonmetall Group Berhad had debt of RM166.9m, up from RM144.9m in one year. However, it also had RM12.6m in cash, and so its net debt is RM154.2m.

debt-equity-history-analysis
KLSE:EMETALL Debt to Equity History February 7th 2021

A Look At Eonmetall Group Berhad's Liabilities

The latest balance sheet data shows that Eonmetall Group Berhad had liabilities of RM157.5m due within a year, and liabilities of RM56.3m falling due after that. Offsetting these obligations, it had cash of RM12.6m as well as receivables valued at RM98.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM102.8m.

This deficit is considerable relative to its market capitalization of RM133.4m, so it does suggest shareholders should keep an eye on Eonmetall Group Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Eonmetall Group Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. The debt burden here is substantial. One redeeming factor for Eonmetall Group Berhad is that it turned last year's EBIT loss into a gain of RM7.6m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Eonmetall Group Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Eonmetall Group Berhad saw substantial negative free cash flow, in total. 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

On the face of it, Eonmetall Group Berhad's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Eonmetall Group Berhad's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. We've identified 5 warning signs with Eonmetall Group Berhad (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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