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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Karyon Industries Berhad (KLSE:KARYON) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Karyon Industries Berhad

What Is Karyon Industries Berhad's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Karyon Industries Berhad had debt of RM8.30m, up from RM7.79m in one year. But on the other hand it also has RM27.1m in cash, leading to a RM18.8m net cash position.

How Strong Is Karyon Industries Berhad's Balance Sheet?

According to the last reported balance sheet, Karyon Industries Berhad had liabilities of RM17.1m due within 12 months, and liabilities of RM9.21m due beyond 12 months. Offsetting this, it had RM27.1m in cash and RM37.8m in receivables that were due within 12 months. So it actually has RM38.7m more liquid assets than total liabilities.

This surplus suggests that Karyon Industries Berhad is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. 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.

On top of that, Karyon Industries Berhad grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Karyon Industries Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Karyon Industries Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Karyon Industries Berhad produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Karyon Industries Berhad has RM18.8m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 31% over the last year. So we don't think Karyon Industries Berhad's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Karyon Industries Berhad (including 2 which are concerning) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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