Sunsuria Berhad (KLSE:SUNSURIA) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Sunsuria Berhad (KLSE:SUNSURIA) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sunsuria Berhad

What Is Sunsuria Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Sunsuria Berhad had debt of RM570.3m, up from RM509.6m in one year. However, because it has a cash reserve of RM346.8m, its net debt is less, at about RM223.4m.

How Strong Is Sunsuria Berhad's Balance Sheet?

The latest balance sheet data shows that Sunsuria Berhad had liabilities of RM442.2m due within a year, and liabilities of RM643.2m falling due after that. On the other hand, it had cash of RM346.8m and RM305.1m worth of receivables due within a year. So it has liabilities totalling RM433.5m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM510.7m, so it does suggest shareholders should keep an eye on Sunsuria Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sunsuria Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (5.2), and fairly weak interest coverage, since EBIT is just 2.4 times the interest expense. The debt burden here is substantial. Another concern for investors might be that Sunsuria Berhad's EBIT fell 17% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sunsuria Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Sunsuria Berhad recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Sunsuria Berhad's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Overall, it seems to us that Sunsuria Berhad's balance sheet is really quite a risk to the business. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Sunsuria Berhad has 3 warning signs (and 2 which are concerning) we think you should know about.

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.