Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Genetec Technology Berhad (KLSE:GENETEC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Genetec Technology Berhad's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2021 Genetec Technology Berhad had RM70.8m of debt, an increase on RM18.8m, over one year. On the flip side, it has RM16.4m in cash leading to net debt of about RM54.4m.
How Strong Is Genetec Technology Berhad's Balance Sheet?
We can see from the most recent balance sheet that Genetec Technology Berhad had liabilities of RM117.0m falling due within a year, and liabilities of RM9.51m due beyond that. Offsetting this, it had RM16.4m in cash and RM162.2m in receivables that were due within 12 months. So it actually has RM52.1m more liquid assets than total liabilities.
This surplus suggests that Genetec Technology Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Genetec Technology Berhad's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 29.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although Genetec Technology Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM42m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Genetec Technology Berhad's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Genetec Technology Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Based on what we've seen Genetec Technology Berhad is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Genetec Technology Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Genetec Technology Berhad (including 1 which is concerning) .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.