Does Seal Berhad (KLSE:SEAL) Have A Healthy Balance Sheet?

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 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 can see that Seal Incorporated Berhad (KLSE:SEAL) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Seal Berhad

What Is Seal Berhad's Debt?

The image below, which you can click on for greater detail, shows that Seal Berhad had debt of RM71.9m at the end of September 2022, a reduction from RM81.3m over a year. However, it also had RM4.25m in cash, and so its net debt is RM67.7m.

How Strong Is Seal Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Seal Berhad had liabilities of RM67.9m due within 12 months and liabilities of RM61.0m due beyond that. On the other hand, it had cash of RM4.25m and RM140.0m worth of receivables due within a year. So it actually has RM15.3m more liquid assets than total liabilities.

This surplus suggests that Seal Berhad is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

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.

Seal Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (15.4), and fairly weak interest coverage, since EBIT is just 2.4 times the interest expense. The debt burden here is substantial. However, the silver lining was that Seal Berhad achieved a positive EBIT of RM4.2m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Seal 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Seal Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Seal Berhad's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its net debt to EBITDA has the opposite effect. All these things considered, it appears that Seal Berhad can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. To that end, you should be aware of the 4 warning signs we've spotted with Seal Berhad .

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.