Does Quality Concrete Holdings Berhad (KLSE:QUALITY) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Quality Concrete Holdings Berhad (KLSE:QUALITY) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Quality Concrete Holdings Berhad

What Is Quality Concrete Holdings Berhad's Net Debt?

As you can see below, at the end of July 2024, Quality Concrete Holdings Berhad had RM101.5m of debt, up from RM88.5m a year ago. Click the image for more detail. However, it does have RM9.95m in cash offsetting this, leading to net debt of about RM91.6m.

How Healthy Is Quality Concrete Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Quality Concrete Holdings Berhad had liabilities of RM185.7m falling due within a year, and liabilities of RM15.6m due beyond that. Offsetting this, it had RM9.95m in cash and RM129.9m in receivables that were due within 12 months. So it has liabilities totalling RM61.5m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM70.7m, so it does suggest shareholders should keep an eye on Quality Concrete Holdings Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.34 times and a disturbingly high net debt to EBITDA ratio of 17.3 hit our confidence in Quality Concrete Holdings Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Quality Concrete Holdings Berhad is that it turned last year's EBIT loss into a gain of RM2.0m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Quality Concrete Holdings Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Quality Concrete Holdings Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Quality Concrete Holdings Berhad's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We're quite clear that we consider Quality Concrete Holdings Berhad to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Quality Concrete Holdings Berhad (1 is concerning) you should be aware of.

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.