HeveaBoard Berhad (KLSE:HEVEA) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 HeveaBoard Berhad (KLSE:HEVEA) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for HeveaBoard Berhad

What Is HeveaBoard Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that HeveaBoard Berhad had debt of RM7.91m at the end of September 2020, a reduction from RM10.0m over a year. But on the other hand it also has RM118.9m in cash, leading to a RM111.0m net cash position.

How Healthy Is HeveaBoard Berhad's Balance Sheet?

We can see from the most recent balance sheet that HeveaBoard Berhad had liabilities of RM71.2m falling due within a year, and liabilities of RM16.5m due beyond that. Offsetting this, it had RM118.9m in cash and RM40.4m in receivables that were due within 12 months. So it actually has RM71.7m more liquid assets than total liabilities.

This excess liquidity suggests that HeveaBoard Berhad is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, HeveaBoard Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that HeveaBoard Berhad saw its EBIT decline by 5.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HeveaBoard Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. HeveaBoard Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, HeveaBoard Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HeveaBoard Berhad has net cash of RM111.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM38m, being 297% of its EBIT. So is HeveaBoard Berhad's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with HeveaBoard Berhad , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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