Is Dagang NeXchange Berhad (KLSE:DNEX) A Risky Investment?

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 Dagang NeXchange Berhad (KLSE:DNEX) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Dagang NeXchange Berhad

How Much Debt Does Dagang NeXchange Berhad Carry?

The chart below, which you can click on for greater detail, shows that Dagang NeXchange Berhad had RM297.4m in debt in December 2023; about the same as the year before. However, its balance sheet shows it holds RM411.0m in cash, so it actually has RM113.6m net cash.

How Strong Is Dagang NeXchange Berhad's Balance Sheet?

We can see from the most recent balance sheet that Dagang NeXchange Berhad had liabilities of RM847.5m falling due within a year, and liabilities of RM1.62b due beyond that. On the other hand, it had cash of RM411.0m and RM329.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM1.73b.

Given this deficit is actually higher than the company's market capitalization of RM1.31b, we think shareholders really should watch Dagang NeXchange Berhad's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Dagang NeXchange Berhad boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Shareholders should be aware that Dagang NeXchange Berhad's EBIT was down 74% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Dagang NeXchange 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Dagang NeXchange 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. Over the last three years, Dagang NeXchange Berhad recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

Although Dagang NeXchange Berhad's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM113.6m. Unfortunately, though, both its struggle EBIT growth rate and its conversion of EBIT to free cash flow leave us concerned about Dagang NeXchange Berhad So despite the cash, we do think it carries some risks. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Dagang NeXchange Berhad you should be aware of.

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. 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.