Is Wang-Zheng Berhad (KLSE:WANGZNG) Using Too Much Debt?

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, Wang-Zheng Berhad (KLSE:WANGZNG) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Wang-Zheng Berhad

What Is Wang-Zheng Berhad's Debt?

As you can see below, Wang-Zheng Berhad had RM60.3m of debt at September 2020, down from RM63.5m a year prior. However, it does have RM124.3m in cash offsetting this, leading to net cash of RM64.0m.

A Look At Wang-Zheng Berhad's Liabilities

We can see from the most recent balance sheet that Wang-Zheng Berhad had liabilities of RM77.2m falling due within a year, and liabilities of RM8.04m due beyond that. Offsetting this, it had RM124.3m in cash and RM59.6m in receivables that were due within 12 months. So it actually has RM98.6m more liquid assets than total liabilities.

This excess liquidity is a great indication that Wang-Zheng Berhad's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Wang-Zheng Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Wang-Zheng Berhad's saving grace is its low debt levels, because its EBIT has tanked 35% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Wang-Zheng Berhad will need earnings to service that debt. 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. While Wang-Zheng Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Wang-Zheng Berhad recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Wang-Zheng Berhad has RM64.0m in net cash and a decent-looking balance sheet. So we are not troubled with Wang-Zheng Berhad's debt use. 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. Case in point: We've spotted 3 warning signs for Wang-Zheng Berhad you should be aware of, and 1 of them is a bit concerning.

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. 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.
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