Is Fiamma Holdings Berhad (KLSE:FIAMMA) Using Too Much Debt?

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.' 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 Fiamma Holdings Berhad (KLSE:FIAMMA) makes use of debt. But should shareholders be worried about its use of debt?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out 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 RM161.7m at the end of March 2021, a reduction from RM186.0m over a year. However, it does have RM126.6m in cash offsetting this, leading to net debt of about RM35.1m.

A Look At Fiamma Holdings Berhad's Liabilities

According to the last reported balance sheet, Fiamma Holdings Berhad had liabilities of RM207.2m due within 12 months, and liabilities of RM58.1m due beyond 12 months. Offsetting these obligations, it had cash of RM126.6m as well as receivables valued at RM105.3m due within 12 months. So it has liabilities totalling RM33.4m more than its cash and near-term receivables, combined.

Of course, Fiamma Holdings Berhad has a market capitalization of RM292.8m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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's net debt is only 0.49 times its EBITDA. And its EBIT covers its interest expense a whopping 14.0 times over. So we're pretty relaxed about its super-conservative use of debt. Also positive, Fiamma Holdings Berhad grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Fiamma Holdings Berhad produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Fiamma Holdings Berhad's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Fiamma Holdings Berhad's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Fiamma Holdings Berhad that you should be aware of before investing here.

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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