Is JHM Consolidation Berhad (KLSE:JHM) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that JHM Consolidation Berhad (KLSE:JHM) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for JHM Consolidation Berhad

What Is JHM Consolidation Berhad's Net Debt?

As you can see below, at the end of March 2021, JHM Consolidation Berhad had RM37.4m of debt, up from RM27.4m a year ago. Click the image for more detail. But it also has RM50.2m in cash to offset that, meaning it has RM12.8m net cash.

A Look At JHM Consolidation Berhad's Liabilities

We can see from the most recent balance sheet that JHM Consolidation Berhad had liabilities of RM62.9m falling due within a year, and liabilities of RM44.1m due beyond that. Offsetting this, it had RM50.2m in cash and RM114.7m in receivables that were due within 12 months. So it actually has RM57.9m more liquid assets than total liabilities.

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

But the other side of the story is that JHM Consolidation Berhad saw its EBIT decline by 2.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if JHM Consolidation 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While JHM Consolidation 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. Looking at the most recent three years, JHM Consolidation Berhad recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case JHM Consolidation Berhad has RM12.8m in net cash and a decent-looking balance sheet. So we are not troubled with JHM Consolidation Berhad's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for JHM Consolidation Berhad that 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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