Is Evergreen Fibreboard Berhad (KLSE:EVERGRN) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Evergreen Fibreboard Berhad (KLSE:EVERGRN) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Evergreen Fibreboard Berhad

What Is Evergreen Fibreboard Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Evergreen Fibreboard Berhad had debt of RM190.2m at the end of June 2022, a reduction from RM226.3m over a year. However, because it has a cash reserve of RM152.7m, its net debt is less, at about RM37.6m.

How Strong Is Evergreen Fibreboard Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Evergreen Fibreboard Berhad had liabilities of RM308.0m due within 12 months and liabilities of RM81.5m due beyond that. Offsetting this, it had RM152.7m in cash and RM142.0m in receivables that were due within 12 months. So it has liabilities totalling RM94.8m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Evergreen Fibreboard Berhad is worth RM375.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

Evergreen Fibreboard Berhad's net debt is only 0.28 times its EBITDA. And its EBIT easily covers its interest expense, being 15.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although Evergreen Fibreboard Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM65m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Evergreen Fibreboard 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. 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, Evergreen Fibreboard Berhad recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Evergreen Fibreboard Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Evergreen Fibreboard Berhad's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. Case in point: We've spotted 2 warning signs for Evergreen Fibreboard Berhad you should be aware of.

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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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.