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 Censof Holdings Berhad (KLSE:CENSOF) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
What Is Censof Holdings Berhad's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Censof Holdings Berhad had RM18.2m of debt in June 2020, down from RM40.6m, one year before. However, its balance sheet shows it holds RM30.7m in cash, so it actually has RM12.6m net cash.
How Strong Is Censof Holdings Berhad's Balance Sheet?
We can see from the most recent balance sheet that Censof Holdings Berhad had liabilities of RM25.8m falling due within a year, and liabilities of RM11.4m due beyond that. On the other hand, it had cash of RM30.7m and RM29.0m worth of receivables due within a year. So it actually has RM22.5m more liquid assets than total liabilities.
This excess liquidity suggests that Censof Holdings Berhad is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Censof Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably, Censof Holdings Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM12m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Censof Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Censof Holdings 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 year, Censof Holdings Berhad generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Censof Holdings Berhad has net cash of RM12.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM12m, being 98% of its EBIT. So we don't think Censof Holdings Berhad's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Censof Holdings Berhad (1 can't be ignored!) that you should be aware of before investing here.
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.
When trading Censof Holdings Berhad or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.