Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Hua Yang Berhad (KLSE:HUAYANG) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Hua Yang Berhad Carry?
As you can see below, Hua Yang Berhad had RM292.5m of debt at March 2021, down from RM319.5m a year prior. However, because it has a cash reserve of RM65.9m, its net debt is less, at about RM226.6m.
How Healthy Is Hua Yang Berhad's Balance Sheet?
The latest balance sheet data shows that Hua Yang Berhad had liabilities of RM212.6m due within a year, and liabilities of RM297.6m falling due after that. On the other hand, it had cash of RM65.9m and RM71.9m worth of receivables due within a year. So it has liabilities totalling RM372.3m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the RM109.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Hua Yang Berhad would probably need a major re-capitalization if its creditors were to demand repayment. 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 Hua Yang 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.
Over 12 months, Hua Yang Berhad made a loss at the EBIT level, and saw its revenue drop to RM160m, which is a fall of 43%. To be frank that doesn't bode well.
Not only did Hua Yang Berhad's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable RM18m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost RM51m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Hua Yang Berhad 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. 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.
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