Is Freight Management Holdings Bhd (KLSE:FREIGHT) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Freight Management Holdings Bhd (KLSE:FREIGHT) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Freight Management Holdings Bhd

What Is Freight Management Holdings Bhd's Debt?

The image below, which you can click on for greater detail, shows that Freight Management Holdings Bhd had debt of RM56.5m at the end of September 2020, a reduction from RM66.5m over a year. However, it does have RM66.7m in cash offsetting this, leading to net cash of RM10.2m.

How Strong Is Freight Management Holdings Bhd's Balance Sheet?

According to the last reported balance sheet, Freight Management Holdings Bhd had liabilities of RM95.4m due within 12 months, and liabilities of RM89.0m due beyond 12 months. Offsetting these obligations, it had cash of RM66.7m as well as receivables valued at RM140.7m due within 12 months. So it can boast RM23.0m more liquid assets than total liabilities.

This surplus suggests that Freight Management Holdings Bhd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Freight Management Holdings Bhd has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly Freight Management Holdings Bhd's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Freight Management Holdings Bhd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Freight Management Holdings Bhd 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 three years, Freight Management Holdings Bhd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Freight Management Holdings Bhd has RM10.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM47m, being 142% of its EBIT. So we don't think Freight Management Holdings Bhd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Freight Management Holdings Bhd you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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