Is YKGI Holdings Berhad (KLSE:YKGI) Using Too Much 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. We note that YKGI Holdings Berhad (KLSE:YKGI) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that YKGI is potentially overvalued!

What Is YKGI Holdings Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 YKGI Holdings Berhad had RM97.1m of debt, an increase on RM82.1m, over one year. However, because it has a cash reserve of RM16.2m, its net debt is less, at about RM81.0m.

How Strong Is YKGI Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that YKGI Holdings Berhad had liabilities of RM124.3m due within 12 months and liabilities of RM30.4m due beyond that. Offsetting these obligations, it had cash of RM16.2m as well as receivables valued at RM52.7m due within 12 months. So its liabilities total RM85.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM47.2m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, YKGI Holdings Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

YKGI Holdings Berhad has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 3.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that YKGI Holdings Berhad grew its EBIT at 20% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is YKGI Holdings 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, YKGI 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 YKGI Holdings Berhad's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider YKGI Holdings Berhad to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that YKGI Holdings Berhad is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.