These 4 Measures Indicate That Rapid Synergy Berhad (KLSE:RAPID) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Rapid Synergy Berhad (KLSE:RAPID) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Rapid Synergy Berhad

How Much Debt Does Rapid Synergy Berhad Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Rapid Synergy Berhad had debt of RM172.2m, up from RM156.8m in one year. However, it also had RM10.6m in cash, and so its net debt is RM161.5m.

A Look At Rapid Synergy Berhad's Liabilities

The latest balance sheet data shows that Rapid Synergy Berhad had liabilities of RM46.5m due within a year, and liabilities of RM139.1m falling due after that. On the other hand, it had cash of RM10.6m and RM13.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM161.4m.

This deficit isn't so bad because Rapid Synergy Berhad is worth RM748.3m, and thus could probably raise enough capital to shore up 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 10.5 hit our confidence in Rapid Synergy Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Rapid Synergy Berhad's EBIT was down 34% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rapid Synergy 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Rapid Synergy Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither Rapid Synergy Berhad's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Rapid Synergy Berhad's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Rapid Synergy Berhad (1 can't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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