Is Karyon Industries Berhad (KLSE:KARYON) Using Too Much Debt?

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 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. We note that Karyon Industries Berhad (KLSE:KARYON) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Karyon Industries Berhad

What Is Karyon Industries Berhad's Net Debt?

As you can see below, Karyon Industries Berhad had RM7.61m of debt at September 2020, down from RM8.49m a year prior. But on the other hand it also has RM45.3m in cash, leading to a RM37.7m net cash position.

A Look At Karyon Industries Berhad's Liabilities

The latest balance sheet data shows that Karyon Industries Berhad had liabilities of RM13.0m due within a year, and liabilities of RM9.62m falling due after that. On the other hand, it had cash of RM45.3m and RM24.5m worth of receivables due within a year. So it can boast RM47.2m more liquid assets than total liabilities.

This excess liquidity is a great indication that Karyon Industries Berhad's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Karyon Industries Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Karyon Industries Berhad has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Karyon Industries 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Karyon Industries 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. Over the most recent three years, Karyon Industries Berhad recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Karyon Industries Berhad has RM37.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in RM16m. So is Karyon Industries Berhad's debt a risk? It doesn't seem so to us. 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. Be aware that Karyon Industries Berhad is showing 2 warning signs in our investment analysis , you should know about...

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. 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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