S P Setia Berhad (KLSE:SPSETIA) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies S P Setia Berhad (KLSE:SPSETIA) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for S P Setia Berhad

What Is S P Setia Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that S P Setia Berhad had RM8.85b of debt in September 2024, down from RM11.1b, one year before. However, it does have RM3.28b in cash offsetting this, leading to net debt of about RM5.57b.

A Look At S P Setia Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that S P Setia Berhad had liabilities of RM4.68b due within 12 months and liabilities of RM7.41b due beyond that. Offsetting these obligations, it had cash of RM3.28b as well as receivables valued at RM1.52b due within 12 months. So it has liabilities totalling RM7.30b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of RM7.00b, 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. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

S P Setia Berhad's debt is 4.1 times its EBITDA, and its EBIT cover its interest expense 5.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. It is well worth noting that S P Setia Berhad's EBIT shot up like bamboo after rain, gaining 47% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual 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 generation warms our hearts like a puppy in a bumblebee suit.

Our View

S P Setia Berhad's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. Considering this range of data points, we think S P Setia Berhad is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for S P Setia Berhad that you should be aware of before investing here.

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.