S P Setia Berhad (KLSE:SPSETIA) Has A Pretty Healthy 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. As with many other companies S P Setia Berhad (KLSE:SPSETIA) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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.

See our latest analysis for S P Setia Berhad

How Much Debt Does S P Setia Berhad Carry?

The image below, which you can click on for greater detail, shows that S P Setia Berhad had debt of RM9.48b at the end of June 2024, a reduction from RM11.8b over a year. However, it does have RM2.94b in cash offsetting this, leading to net debt of about RM6.55b.

How Healthy Is S P Setia Berhad's Balance Sheet?

We can see from the most recent balance sheet that S P Setia Berhad had liabilities of RM5.11b falling due within a year, and liabilities of RM7.49b due beyond that. Offsetting this, it had RM2.94b in cash and RM2.04b in receivables that were due within 12 months. So it has liabilities totalling RM7.61b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of RM6.75b, we think shareholders really should watch S P Setia Berhad's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

S P Setia Berhad has a rather high debt to EBITDA ratio of 5.2 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.9 times, suggesting it can responsibly service its obligations. It is well worth noting that S P Setia Berhad's EBIT shot up like bamboo after rain, gaining 54% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if S P Setia Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, S P Setia Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Both S P Setia Berhad's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its net debt to EBITDA had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about S P Setia Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. We've identified 4 warning signs with S P Setia Berhad (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.