Here's Why Scientex Berhad (KLSE:SCIENTX) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Scientex Berhad (KLSE:SCIENTX) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Scientex Berhad

What Is Scientex Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of April 2022 Scientex Berhad had RM1.30b of debt, an increase on RM1.02b, over one year. However, it does have RM115.4m in cash offsetting this, leading to net debt of about RM1.18b.

How Healthy Is Scientex Berhad's Balance Sheet?

The latest balance sheet data shows that Scientex Berhad had liabilities of RM1.78b due within a year, and liabilities of RM431.9m falling due after that. Offsetting these obligations, it had cash of RM115.4m as well as receivables valued at RM946.3m due within 12 months. So it has liabilities totalling RM1.15b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Scientex Berhad is worth RM5.68b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Scientex Berhad's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its commanding EBIT of 26.2 times its interest expense, implies the debt load is as light as a peacock feather. The bad news is that Scientex Berhad saw its EBIT decline by 13% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Scientex Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Scientex Berhad generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Scientex Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that Scientex Berhad can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. To that end, you should be aware of the 1 warning sign we've spotted with Scientex Berhad .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.