Stock Analysis

GHL Systems Berhad (KLSE:GHLSYS) Has A Pretty Healthy Balance Sheet

KLSE:GHLSYS
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that GHL Systems Berhad (KLSE:GHLSYS) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for GHL Systems Berhad

What Is GHL Systems Berhad's Debt?

As you can see below, GHL Systems Berhad had RM22.2m of debt at December 2020, down from RM26.2m a year prior. However, it does have RM216.5m in cash offsetting this, leading to net cash of RM194.4m.

debt-equity-history-analysis
KLSE:GHLSYS Debt to Equity History May 3rd 2021

How Healthy Is GHL Systems Berhad's Balance Sheet?

The latest balance sheet data shows that GHL Systems Berhad had liabilities of RM180.7m due within a year, and liabilities of RM23.8m falling due after that. On the other hand, it had cash of RM216.5m and RM82.2m worth of receivables due within a year. So it can boast RM94.2m more liquid assets than total liabilities.

This surplus suggests that GHL Systems Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that GHL Systems Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact GHL Systems Berhad's saving grace is its low debt levels, because its EBIT has tanked 49% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GHL Systems 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. While GHL Systems Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, GHL Systems Berhad produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case GHL Systems Berhad has RM194.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in RM27m. So we don't have any problem with GHL Systems Berhad's use of debt. 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. For example, we've discovered 1 warning sign for GHL Systems Berhad that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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