We Think JHM Consolidation Berhad (KLSE:JHM) Can Stay On Top Of Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that JHM Consolidation Berhad (KLSE:JHM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for JHM Consolidation Berhad

What Is JHM Consolidation Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that JHM Consolidation Berhad had debt of RM35.0m at the end of December 2020, a reduction from RM40.3m over a year. On the flip side, it has RM30.7m in cash leading to net debt of about RM4.27m.

A Look At JHM Consolidation Berhad's Liabilities

We can see from the most recent balance sheet that JHM Consolidation Berhad had liabilities of RM79.5m falling due within a year, and liabilities of RM37.3m due beyond that. Offsetting these obligations, it had cash of RM30.7m as well as receivables valued at RM138.8m due within 12 months. So it can boast RM52.7m 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. Carrying virtually no net debt, JHM Consolidation Berhad has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

JHM Consolidation Berhad's net debt is only 0.10 times its EBITDA. And its EBIT easily covers its interest expense, being 15.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that JHM Consolidation Berhad's load is not too heavy, because its EBIT was down 24% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, JHM Consolidation Berhad reported free cash flow worth 9.3% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

JHM Consolidation Berhad's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about JHM Consolidation Berhad's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that JHM Consolidation Berhad is showing 1 warning sign in our investment analysis , you should know about...

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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