Is Teo Guan Lee Corporation Berhad (KLSE:TGL) Using Too Much Debt?

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 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. As with many other companies Teo Guan Lee Corporation Berhad (KLSE:TGL) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Teo Guan Lee Corporation Berhad

What Is Teo Guan Lee Corporation Berhad's Debt?

As you can see below, Teo Guan Lee Corporation Berhad had RM7.28m of debt at December 2020, down from RM7.62m a year prior. However, it does have RM37.1m in cash offsetting this, leading to net cash of RM29.8m.

How Healthy Is Teo Guan Lee Corporation Berhad's Balance Sheet?

According to the last reported balance sheet, Teo Guan Lee Corporation Berhad had liabilities of RM18.0m due within 12 months, and liabilities of RM8.00m due beyond 12 months. Offsetting these obligations, it had cash of RM37.1m as well as receivables valued at RM19.4m due within 12 months. So it actually has RM30.5m more liquid assets than total liabilities.

This surplus liquidity suggests that Teo Guan Lee Corporation Berhad's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Teo Guan Lee Corporation Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Teo Guan Lee Corporation Berhad's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Teo Guan Lee Corporation 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Teo Guan Lee Corporation Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Teo Guan Lee Corporation Berhad generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Teo Guan Lee Corporation Berhad has net cash of RM29.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM6.1m, being 92% of its EBIT. So we don't think Teo Guan Lee Corporation Berhad's use of debt is risky. 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. We've identified 3 warning signs with Teo Guan Lee Corporation Berhad , and understanding them should be part of your investment process.

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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