We Think Fiamma Holdings Berhad (KLSE:FIAMMA) Can Stay On Top Of Its 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 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. Importantly, Fiamma Holdings Berhad (KLSE:FIAMMA) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Fiamma Holdings Berhad

What Is Fiamma Holdings Berhad's Debt?

The chart below, which you can click on for greater detail, shows that Fiamma Holdings Berhad had RM157.3m in debt in March 2022; about the same as the year before. However, it also had RM129.1m in cash, and so its net debt is RM28.1m.

How Strong Is Fiamma Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Fiamma Holdings Berhad had liabilities of RM185.0m due within a year, and liabilities of RM45.5m falling due after that. Offsetting this, it had RM129.1m in cash and RM94.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM6.80m.

Having regard to Fiamma Holdings Berhad's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the RM403.5m company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Fiamma Holdings Berhad's net debt is only 0.50 times its EBITDA. And its EBIT easily covers its interest expense, being 17.4 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Fiamma Holdings Berhad if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Fiamma Holdings Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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 64% 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 interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its EBIT growth rate has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Fiamma Holdings Berhad can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Fiamma Holdings Berhad that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.