Here's Why Golden Pharos Berhad (KLSE:GPHAROS) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Golden Pharos Berhad (KLSE:GPHAROS) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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

View our latest analysis for Golden Pharos Berhad

What Is Golden Pharos Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Golden Pharos Berhad had debt of RM11.3m at the end of June 2023, a reduction from RM12.1m over a year. However, it does have RM10.7m in cash offsetting this, leading to net debt of about RM570.0k.

How Healthy Is Golden Pharos Berhad's Balance Sheet?

According to the last reported balance sheet, Golden Pharos Berhad had liabilities of RM17.6m due within 12 months, and liabilities of RM14.3m due beyond 12 months. Offsetting this, it had RM10.7m in cash and RM24.1m in receivables that were due within 12 months. So it can boast RM2.90m more liquid assets than total liabilities.

This short term liquidity is a sign that Golden Pharos Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. But either way, Golden Pharos Berhad has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.03 times EBITDA and EBIT covering interest a whopping 26.1 times, it's clear that Golden Pharos Berhad is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. Better yet, Golden Pharos Berhad grew its EBIT by 119% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Golden Pharos 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Golden Pharos Berhad reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that Golden Pharos Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at the bigger picture, we think Golden Pharos Berhad's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Golden Pharos Berhad (1 is concerning) you should be aware of.

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. 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.