Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, PeterLabs Holdings Berhad (KLSE:PLABS) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is PeterLabs Holdings Berhad's Debt?
As you can see below, PeterLabs Holdings Berhad had RM17.0m of debt at December 2024, down from RM18.6m a year prior. However, it does have RM13.7m in cash offsetting this, leading to net debt of about RM3.31m.
How Healthy Is PeterLabs Holdings Berhad's Balance Sheet?
We can see from the most recent balance sheet that PeterLabs Holdings Berhad had liabilities of RM36.1m falling due within a year, and liabilities of RM1.94m due beyond that. On the other hand, it had cash of RM13.7m and RM43.0m worth of receivables due within a year. So it can boast RM18.7m more liquid assets than total liabilities.
It's good to see that PeterLabs Holdings Berhad has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.
Check out our latest analysis for PeterLabs Holdings Berhad
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.
Looking at its net debt to EBITDA of 0.49 and interest cover of 6.2 times, it seems to us that PeterLabs Holdings Berhad is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Fortunately, PeterLabs Holdings Berhad grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is PeterLabs 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. Looking at the most recent three years, PeterLabs Holdings Berhad recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
The good news is that PeterLabs Holdings Berhad's demonstrated ability handle its debt, based on its EBITDA, delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its level of total liabilities also supports that impression! When we consider the range of factors above, it looks like PeterLabs Holdings Berhad is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. We've identified 2 warning signs with PeterLabs Holdings Berhad (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.