Is Country Heights Holdings Berhad (KLSE:CHHB) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Country Heights Holdings Berhad (KLSE:CHHB) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Country Heights Holdings Berhad

What Is Country Heights Holdings Berhad's Net Debt?

The chart below, which you can click on for greater detail, shows that Country Heights Holdings Berhad had RM199.0m in debt in September 2021; about the same as the year before. However, it also had RM11.7m in cash, and so its net debt is RM187.3m.

How Strong Is Country Heights Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Country Heights Holdings Berhad had liabilities of RM243.0m due within a year, and liabilities of RM263.9m falling due after that. On the other hand, it had cash of RM11.7m and RM43.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM451.5m.

This deficit is considerable relative to its market capitalization of RM522.5m, so it does suggest shareholders should keep an eye on Country Heights Holdings Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). 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).

Weak interest cover of 0.45 times and a disturbingly high net debt to EBITDA ratio of 21.2 hit our confidence in Country Heights Holdings Berhad like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Country Heights Holdings Berhad is that it turned last year's EBIT loss into a gain of RM4.5m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Country Heights Holdings Berhad will need earnings to service that debt. 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, Country Heights Holdings Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Country Heights Holdings Berhad's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. Overall, it seems to us that Country Heights Holdings Berhad's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Country Heights Holdings Berhad has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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.