K. Seng Seng Corporation Berhad (KLSE:KSSC) Takes On Some Risk With Its Use Of 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, K. Seng Seng Corporation Berhad (KLSE:KSSC) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for K. Seng Seng Corporation Berhad

What Is K. Seng Seng Corporation Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 K. Seng Seng Corporation Berhad had RM76.0m of debt, an increase on RM44.5m, over one year. However, it also had RM17.5m in cash, and so its net debt is RM58.5m.

A Look At K. Seng Seng Corporation Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that K. Seng Seng Corporation Berhad had liabilities of RM99.9m due within 12 months and liabilities of RM8.23m due beyond that. Offsetting these obligations, it had cash of RM17.5m as well as receivables valued at RM71.2m due within 12 months. So its liabilities total RM19.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since K. Seng Seng Corporation Berhad has a market capitalization of RM66.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

K. Seng Seng Corporation Berhad's debt is 3.8 times its EBITDA, and its EBIT cover its interest expense 6.6 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. It is well worth noting that K. Seng Seng Corporation Berhad's EBIT shot up like bamboo after rain, gaining 33% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is K. Seng Seng Corporation Berhad's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, K. Seng Seng Corporation Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

K. Seng Seng Corporation Berhad's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that K. Seng Seng Corporation Berhad's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for K. Seng Seng Corporation Berhad (of which 2 don't sit too well with us!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.