Is QES Group Berhad (KLSE:QES) A Risky Investment?

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.' 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. Importantly, QES Group Berhad (KLSE:QES) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for QES Group Berhad

What Is QES Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 QES Group Berhad had debt of RM32.0m, up from RM14.4m in one year. However, it does have RM71.9m in cash offsetting this, leading to net cash of RM40.0m.

A Look At QES Group Berhad's Liabilities

According to the last reported balance sheet, QES Group Berhad had liabilities of RM63.7m due within 12 months, and liabilities of RM21.1m due beyond 12 months. Offsetting this, it had RM71.9m in cash and RM55.5m in receivables that were due within 12 months. So it actually has RM42.7m more liquid assets than total liabilities.

This short term liquidity is a sign that QES Group Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that QES Group Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, QES Group Berhad grew its EBIT by 209% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is QES Group Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While QES Group 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. Over the last three years, QES Group Berhad recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that QES Group Berhad has net cash of RM40.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 209% year-on-year EBIT growth. So we are not troubled with QES Group Berhad's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for QES Group Berhad (2 are potentially serious) you should be aware of.

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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