GHL Systems Berhad (KLSE:GHLSYS) Seems To Use Debt Quite Sensibly

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 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. Importantly, GHL Systems Berhad (KLSE:GHLSYS) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for GHL Systems Berhad

How Much Debt Does GHL Systems Berhad Carry?

The image below, which you can click on for greater detail, shows that GHL Systems Berhad had debt of RM18.3m at the end of September 2022, a reduction from RM53.9m over a year. But on the other hand it also has RM232.8m in cash, leading to a RM214.5m net cash position.

How Healthy Is GHL Systems Berhad's Balance Sheet?

The latest balance sheet data shows that GHL Systems Berhad had liabilities of RM181.0m due within a year, and liabilities of RM19.4m falling due after that. Offsetting these obligations, it had cash of RM232.8m as well as receivables valued at RM147.3m due within 12 months. So it actually has RM179.7m more liquid assets than total liabilities.

This excess liquidity suggests that GHL Systems Berhad is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. 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.

But the bad news is that GHL Systems Berhad has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine GHL Systems 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, a company can only pay off debt with cold hard cash, not accounting profits. GHL Systems 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, GHL Systems Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case GHL Systems Berhad has RM214.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM15m, being 129% of its EBIT. So is GHL Systems Berhad's debt a risk? It doesn't seem so to us. 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 - GHL Systems Berhad has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.