Is Selangor Dredging Berhad (KLSE:SDRED) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Selangor Dredging Berhad (KLSE:SDRED) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Selangor Dredging Berhad

What Is Selangor Dredging Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Selangor Dredging Berhad had RM438.2m of debt, an increase on RM398.9m, over one year. However, because it has a cash reserve of RM53.2m, its net debt is less, at about RM385.0m.

How Healthy Is Selangor Dredging Berhad's Balance Sheet?

According to the last reported balance sheet, Selangor Dredging Berhad had liabilities of RM380.1m due within 12 months, and liabilities of RM181.7m due beyond 12 months. On the other hand, it had cash of RM53.2m and RM130.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM377.6m.

This deficit casts a shadow over the RM221.6m 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. There's no doubt that we learn most about debt from the balance sheet. But it is Selangor Dredging 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.

Over 12 months, Selangor Dredging Berhad made a loss at the EBIT level, and saw its revenue drop to RM154m, which is a fall of 44%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Selangor Dredging Berhad's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at RM18m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of RM12m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Selangor Dredging Berhad (of which 2 are significant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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