Is Sedania Innovator Berhad (KLSE:SEDANIA) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Sedania Innovator Berhad (KLSE:SEDANIA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sedania Innovator Berhad

What Is Sedania Innovator Berhad's Debt?

As you can see below, at the end of September 2022, Sedania Innovator Berhad had RM9.44m of debt, up from RM5.67m a year ago. Click the image for more detail. However, its balance sheet shows it holds RM12.1m in cash, so it actually has RM2.69m net cash.

A Look At Sedania Innovator Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Sedania Innovator Berhad had liabilities of RM9.48m due within 12 months and liabilities of RM3.84m due beyond that. Offsetting this, it had RM12.1m in cash and RM12.9m in receivables that were due within 12 months. So it actually has RM11.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Sedania Innovator Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Sedania Innovator Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sedania Innovator Berhad's saving grace is its low debt levels, because its EBIT has tanked 43% in the last twelve months. 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 it is Sedania Innovator Berhad's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sedania Innovator 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. Over the last two years, Sedania Innovator Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sedania Innovator Berhad has RM2.69m in net cash and a decent-looking balance sheet. So while Sedania Innovator Berhad does not have a great balance sheet, it's certainly not too bad. 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 2 warning signs for Sedania Innovator Berhad that 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. 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.