JHM Consolidation Berhad (KLSE:JHM) Seems To Use Debt Quite Sensibly

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. As with many other companies JHM Consolidation Berhad (KLSE:JHM) makes use of debt. But the real question is whether this debt is making the company risky.

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

Check out our latest analysis for JHM Consolidation Berhad

What Is JHM Consolidation Berhad's Net Debt?

As you can see below, JHM Consolidation Berhad had RM25.4m of debt at September 2020, down from RM31.5m a year prior. However, it does have RM43.9m in cash offsetting this, leading to net cash of RM18.5m.

How Healthy Is JHM Consolidation Berhad's Balance Sheet?

According to the last reported balance sheet, JHM Consolidation Berhad had liabilities of RM74.4m due within 12 months, and liabilities of RM34.8m due beyond 12 months. On the other hand, it had cash of RM43.9m and RM115.1m worth of receivables due within a year. So it can boast RM49.8m 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. Succinctly put, JHM Consolidation Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for JHM Consolidation Berhad if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if JHM Consolidation Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. JHM Consolidation 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. Looking at the most recent three years, JHM Consolidation Berhad recorded free cash flow of 39% 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 RM18.5m in net cash and a decent-looking balance sheet. So we don't have any problem with JHM Consolidation 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 instance, we've identified 2 warning signs 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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