These 4 Measures Indicate That SBC Corporation Berhad (KLSE:SBCCORP) Is Using Debt In A Risky Way

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.' 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. Importantly, SBC Corporation Berhad (KLSE:SBCCORP) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SBC Corporation Berhad

How Much Debt Does SBC Corporation Berhad Carry?

As you can see below, at the end of September 2020, SBC Corporation Berhad had RM111.2m of debt, up from RM59.5m a year ago. Click the image for more detail. However, it does have RM9.50m in cash offsetting this, leading to net debt of about RM101.7m.

How Strong Is SBC Corporation Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SBC Corporation Berhad had liabilities of RM174.4m due within 12 months and liabilities of RM76.7m due beyond that. On the other hand, it had cash of RM9.50m and RM50.6m worth of receivables due within a year. So its liabilities total RM190.9m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM100.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, SBC Corporation Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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.

SBC Corporation Berhad has a rather high debt to EBITDA ratio of 15.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.2 times, suggesting it can responsibly service its obligations. Worse, SBC Corporation Berhad's EBIT was down 86% 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. There's no doubt that we learn most about debt from the balance sheet. But it is SBC Corporation Berhad's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, SBC Corporation Berhad actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

To be frank both SBC Corporation Berhad's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. Considering all the factors previously mentioned, we think that SBC Corporation Berhad really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with SBC Corporation Berhad , and understanding them should be part of your investment process.

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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