Kamdar Group (M) Berhad (KLSE:KAMDAR) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Kamdar Group (M) Berhad (KLSE:KAMDAR) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. 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 Kamdar Group (M) Berhad

How Much Debt Does Kamdar Group (M) Berhad Carry?

The image below, which you can click on for greater detail, shows that at March 2023 Kamdar Group (M) Berhad had debt of RM55.5m, up from RM51.3m in one year. On the flip side, it has RM19.2m in cash leading to net debt of about RM36.3m.

How Healthy Is Kamdar Group (M) Berhad's Balance Sheet?

According to the last reported balance sheet, Kamdar Group (M) Berhad had liabilities of RM27.8m due within 12 months, and liabilities of RM39.8m due beyond 12 months. On the other hand, it had cash of RM19.2m and RM6.99m worth of receivables due within a year. So its liabilities total RM41.4m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM49.5m, so it does suggest shareholders should keep an eye on Kamdar Group (M) Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kamdar Group (M) Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (50.1), and fairly weak interest coverage, since EBIT is just 0.29 times the interest expense. The debt burden here is substantial. However, the silver lining was that Kamdar Group (M) Berhad achieved a positive EBIT of RM784k in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kamdar Group (M) Berhad will need earnings to service that debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Kamdar Group (M) Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Neither Kamdar Group (M) Berhad's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Kamdar Group (M) Berhad's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 3 warning signs for Kamdar Group (M) Berhad you should be aware of, and 1 of them is a bit unpleasant.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.