Scientex Berhad (KLSE:SCIENTX) Has A Rock Solid Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Scientex Berhad (KLSE:SCIENTX) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Scientex Berhad

How Much Debt Does Scientex Berhad Carry?

The image below, which you can click on for greater detail, shows that at July 2020 Scientex Berhad had debt of RM1.04b, up from RM972.6m in one year. On the flip side, it has RM413.2m in cash leading to net debt of about RM627.8m.

How Healthy Is Scientex Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Scientex Berhad had liabilities of RM1.35b due within 12 months and liabilities of RM491.6m due beyond that. Offsetting this, it had RM413.2m in cash and RM565.5m in receivables that were due within 12 months. So it has liabilities totalling RM866.1m more than its cash and near-term receivables, combined.

Since publicly traded Scientex Berhad shares are worth a total of RM6.30b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Scientex Berhad has a low net debt to EBITDA ratio of only 0.93. And its EBIT easily covers its interest expense, being 34.8 times the size. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Scientex Berhad has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Scientex Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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, Scientex Berhad generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Scientex Berhad's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Scientex Berhad is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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. Take risks, for example - Scientex Berhad has 1 warning sign we think you should be aware of.

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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