Does Eco World International Berhad (KLSE:EWINT) Have A Healthy 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Eco World International Berhad (KLSE:EWINT) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Eco World International Berhad

What Is Eco World International Berhad's Debt?

The image below, which you can click on for greater detail, shows that Eco World International Berhad had debt of RM1.28b at the end of January 2021, a reduction from RM1.54b over a year. However, it does have RM576.9m in cash offsetting this, leading to net debt of about RM704.6m.

A Look At Eco World International Berhad's Liabilities

The latest balance sheet data shows that Eco World International Berhad had liabilities of RM900.4m due within a year, and liabilities of RM485.1m falling due after that. Offsetting this, it had RM576.9m in cash and RM23.2m in receivables that were due within 12 months. So its liabilities total RM785.4m more than the combination of its cash and short-term receivables.

Eco World International Berhad has a market capitalization of RM1.32b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 8.6, it's fair to say Eco World International Berhad does have a significant amount of debt. However, its interest coverage of 3.0 is reasonably strong, which is a good sign. However, the silver lining was that Eco World International Berhad achieved a positive EBIT of RM81m in the last twelve months, an improvement on the prior year's loss. 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 Eco World International 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Eco World International 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

Eco World International Berhad's net debt to EBITDA and interest cover definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. We think that Eco World International Berhad's debt does make it a bit risky, after considering the aforementioned data points together. 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, we've discovered 6 warning signs for Eco World International Berhad (1 shouldn't be ignored!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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