Is Tanco Holdings Berhad (KLSE:TANCO) Using Too Much Debt?

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, Tanco Holdings Berhad (KLSE:TANCO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Tanco Holdings Berhad

What Is Tanco Holdings Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Tanco Holdings Berhad had debt of RM9.31m at the end of March 2024, a reduction from RM24.4m over a year. However, it does have RM2.98m in cash offsetting this, leading to net debt of about RM6.33m.

How Strong Is Tanco Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tanco Holdings Berhad had liabilities of RM144.0m due within 12 months and liabilities of RM9.12m due beyond that. Offsetting this, it had RM2.98m in cash and RM141.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM8.48m.

This state of affairs indicates that Tanco Holdings Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM2.02b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Tanco Holdings Berhad has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Given net debt is only 0.32 times EBITDA, it is initially surprising to see that Tanco Holdings Berhad's EBIT has low interest coverage of 2.5 times. So one way or the other, it's clear the debt levels are not trivial. Notably, Tanco Holdings Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM18m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Tanco Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Tanco Holdings Berhad saw substantial negative free cash flow, in total. 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

Tanco Holdings Berhad's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its net debt to EBITDA was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Tanco Holdings Berhad is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example - Tanco Holdings Berhad has 2 warning signs we think you should be aware of.

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.

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