Is SMTrack Berhad (KLSE:SMTRACK) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 SMTrack Berhad (KLSE:SMTRACK) does have debt on its balance sheet. 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SMTrack Berhad

How Much Debt Does SMTrack Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 SMTrack Berhad had RM17.7m of debt, an increase on RM16.8m, over one year. On the flip side, it has RM664.0k in cash leading to net debt of about RM17.0m.

How Strong Is SMTrack Berhad's Balance Sheet?

We can see from the most recent balance sheet that SMTrack Berhad had liabilities of RM15.3m falling due within a year, and liabilities of RM17.6m due beyond that. Offsetting these obligations, it had cash of RM664.0k as well as receivables valued at RM17.3m due within 12 months. So it has liabilities totalling RM14.9m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM19.8m, so it does suggest shareholders should keep an eye on SMTrack Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 2.1, SMTrack Berhad uses debt artfully but responsibly. And the alluring interest cover (EBIT of 9.5 times interest expense) certainly does not do anything to dispel this impression. Notably, SMTrack Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM5.7m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SMTrack Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, SMTrack Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We'd go so far as to say SMTrack Berhad's conversion of EBIT to free cash flow was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making SMTrack Berhad stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should learn about the 4 warning signs we've spotted with SMTrack Berhad (including 2 which are a bit unpleasant) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.