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. As with many other companies Dagang NeXchange Berhad (KLSE:DNEX) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Dagang NeXchange Berhad's Debt?
The image below, which you can click on for greater detail, shows that Dagang NeXchange Berhad had debt of RM86.4m at the end of June 2021, a reduction from RM108.8m over a year. But it also has RM270.2m in cash to offset that, meaning it has RM183.9m net cash.
How Healthy Is Dagang NeXchange Berhad's Balance Sheet?
According to the last reported balance sheet, Dagang NeXchange Berhad had liabilities of RM230.3m due within 12 months, and liabilities of RM896.0m due beyond 12 months. Offsetting this, it had RM270.2m in cash and RM95.7m in receivables that were due within 12 months. So it has liabilities totalling RM760.3m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Dagang NeXchange Berhad has a market capitalization of RM2.65b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Dagang NeXchange Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Dagang NeXchange Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM24m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Dagang NeXchange 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.
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 year, Dagang NeXchange Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
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 RM183.9m. So while Dagang NeXchange Berhad does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Dagang NeXchange Berhad has 3 warning signs (and 2 which can't be ignored) we think you should know about.
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.
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