These 4 Measures Indicate That OCK Group Berhad (KLSE:OCK) Is Using Debt Extensively

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.' 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 can see that OCK Group Berhad (KLSE:OCK) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

Check out our latest analysis for OCK Group Berhad

What Is OCK Group Berhad's Net Debt?

As you can see below, OCK Group Berhad had RM458.4m of debt at June 2020, down from RM491.7m a year prior. On the flip side, it has RM97.8m in cash leading to net debt of about RM360.5m.

A Look At OCK Group Berhad's Liabilities

According to the last reported balance sheet, OCK Group Berhad had liabilities of RM357.7m due within 12 months, and liabilities of RM427.3m due beyond 12 months. Offsetting these obligations, it had cash of RM97.8m as well as receivables valued at RM308.0m due within 12 months. So its liabilities total RM379.2m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM417.0m, so it does suggest shareholders should keep an eye on OCK Group Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

While we wouldn't worry about OCK Group Berhad's net debt to EBITDA ratio of 3.0, we think its super-low interest cover of 2.3 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Fortunately, OCK Group Berhad grew its EBIT by 2.5% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if OCK Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, OCK Group Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over OCK Group Berhad's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. We're quite clear that we consider OCK Group Berhad to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 1 warning sign for OCK Group Berhad 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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