We Think Ideal Capital Berhad (KLSE:IDEAL) Can Manage Its Debt With Ease

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. We note that Ideal Capital Berhad (KLSE:IDEAL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 Ideal Capital Berhad

What Is Ideal Capital Berhad's Debt?

The image below, which you can click on for greater detail, shows that Ideal Capital Berhad had debt of RM103.9m at the end of March 2022, a reduction from RM124.5m over a year. However, because it has a cash reserve of RM50.6m, its net debt is less, at about RM53.3m.

How Healthy Is Ideal Capital Berhad's Balance Sheet?

We can see from the most recent balance sheet that Ideal Capital Berhad had liabilities of RM275.0m falling due within a year, and liabilities of RM103.9m due beyond that. Offsetting this, it had RM50.6m in cash and RM150.1m in receivables that were due within 12 months. So its liabilities total RM178.2m more than the combination of its cash and short-term receivables.

Ideal Capital Berhad has a market capitalization of RM825.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ideal Capital Berhad has a low net debt to EBITDA ratio of only 0.82. And its EBIT covers its interest expense a whopping 16.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Ideal Capital Berhad grew its EBIT by 106% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Ideal Capital Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Ideal Capital Berhad produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Ideal Capital Berhad's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Ideal Capital Berhad is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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. We've identified 2 warning signs with Ideal Capital Berhad (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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.