Does Selangor Dredging Berhad (KLSE:SDRED) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Selangor Dredging Berhad (KLSE:SDRED) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for Selangor Dredging Berhad

What Is Selangor Dredging Berhad's Net Debt?

The chart below, which you can click on for greater detail, shows that Selangor Dredging Berhad had RM432.6m in debt in September 2020; about the same as the year before. However, it also had RM41.9m in cash, and so its net debt is RM390.6m.

A Look At Selangor Dredging Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Selangor Dredging Berhad had liabilities of RM400.5m due within 12 months and liabilities of RM157.3m due beyond that. Offsetting these obligations, it had cash of RM41.9m as well as receivables valued at RM118.6m due within 12 months. So its liabilities total RM397.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM215.2m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Selangor Dredging Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Selangor Dredging Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (44.8), and fairly weak interest coverage, since EBIT is just 0.17 times the interest expense. The debt burden here is substantial. Even worse, Selangor Dredging Berhad saw its EBIT tank 89% over the last 12 months. 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 you can't view debt in total isolation; since Selangor Dredging Berhad will need earnings to service that debt. 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 we always check how much of that EBIT is translated into free cash flow. In the last two years, Selangor Dredging Berhad's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Selangor Dredging Berhad's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its conversion of EBIT to free cash flow is not so bad. After considering the datapoints discussed, we think Selangor Dredging Berhad has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Selangor Dredging Berhad has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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