These 4 Measures Indicate That Leader Steel Holdings Berhad (KLSE:LSTEEL) Is Using Debt Extensively

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.' 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, Leader Steel Holdings Berhad (KLSE:LSTEEL) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Leader Steel Holdings Berhad

How Much Debt Does Leader Steel Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Leader Steel Holdings Berhad had debt of RM61.3m, up from RM57.7m in one year. However, it also had RM10.1m in cash, and so its net debt is RM51.2m.

How Strong Is Leader Steel Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Leader Steel Holdings Berhad had liabilities of RM71.3m falling due within a year, and liabilities of RM15.8m due beyond that. Offsetting this, it had RM10.1m in cash and RM76.1m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Leader Steel Holdings Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM77.3m company is short on cash, but still worth keeping an eye on the balance sheet.

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.

Weak interest cover of 0.063 times and a disturbingly high net debt to EBITDA ratio of 10.9 hit our confidence in Leader Steel Holdings Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Leader Steel Holdings Berhad saw its EBIT tank 99% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Leader Steel Holdings 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Leader Steel Holdings Berhad produced sturdy free cash flow equating to 61% 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.

Our View

Both Leader Steel Holdings Berhad's EBIT growth rate and its interest cover were discouraging. At least its conversion of EBIT to free cash flow gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Leader Steel Holdings Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 example, we've discovered 5 warning signs for Leader Steel Holdings Berhad (1 is a bit unpleasant!) that you should be aware of before investing here.

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.