South Malaysia Industries Berhad (KLSE:SMI) Is Carrying A Fair Bit Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, South Malaysia Industries Berhad (KLSE:SMI) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Our analysis indicates that SMI is potentially overvalued!

What Is South Malaysia Industries Berhad's Debt?

The image below, which you can click on for greater detail, shows that South Malaysia Industries Berhad had debt of RM19.1m at the end of June 2022, a reduction from RM21.5m over a year. However, it does have RM9.69m in cash offsetting this, leading to net debt of about RM9.37m.

How Strong Is South Malaysia Industries Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that South Malaysia Industries Berhad had liabilities of RM17.8m due within 12 months and liabilities of RM12.6m due beyond that. Offsetting these obligations, it had cash of RM9.69m as well as receivables valued at RM14.9m due within 12 months. So its liabilities total RM5.78m more than the combination of its cash and short-term receivables.

Of course, South Malaysia Industries Berhad has a market capitalization of RM78.7m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is South Malaysia Industries Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, South Malaysia Industries Berhad made a loss at the EBIT level, and saw its revenue drop to RM48m, which is a fall of 17%. That's not what we would hope to see.

Caveat Emptor

Not only did South Malaysia Industries Berhad's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost RM280k at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of RM4.2m. So we do think this stock is quite risky. 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. For instance, we've identified 3 warning signs for South Malaysia Industries Berhad (2 don't sit too well with us) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.