Does Fiamma Holdings Berhad (KLSE:FIAMMA) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Fiamma Holdings Berhad (KLSE:FIAMMA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Fiamma Holdings Berhad

What Is Fiamma Holdings Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Fiamma Holdings Berhad had debt of RM174.4m at the end of December 2020, a reduction from RM196.8m over a year. However, it does have RM124.7m in cash offsetting this, leading to net debt of about RM49.7m.

A Look At Fiamma Holdings Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Fiamma Holdings Berhad had liabilities of RM219.1m due within 12 months and liabilities of RM63.6m due beyond that. Offsetting this, it had RM124.7m in cash and RM104.1m in receivables that were due within 12 months. So it has liabilities totalling RM53.9m more than its cash and near-term receivables, combined.

Given Fiamma Holdings Berhad has a market capitalization of RM290.2m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fiamma Holdings Berhad has a low net debt to EBITDA ratio of only 0.64. And its EBIT easily covers its interest expense, being 11.6 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Fiamma Holdings Berhad grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Fiamma Holdings 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Fiamma Holdings Berhad produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Fiamma Holdings Berhad's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its interest cover also supports that impression! Looking at the bigger picture, we think Fiamma Holdings Berhad's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that Fiamma Holdings Berhad is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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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