Hubline Berhad (KLSE:HUBLINE) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Hubline Berhad (KLSE:HUBLINE) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hubline Berhad

What Is Hubline Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Hubline Berhad had RM78.5m of debt, an increase on RM70.3m, over one year. However, it also had RM12.9m in cash, and so its net debt is RM65.5m.

A Look At Hubline Berhad's Liabilities

The latest balance sheet data shows that Hubline Berhad had liabilities of RM89.6m due within a year, and liabilities of RM61.5m falling due after that. Offsetting this, it had RM12.9m in cash and RM21.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM116.7m.

This deficit is considerable relative to its market capitalization of RM187.2m, so it does suggest shareholders should keep an eye on Hubline Berhad's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hubline Berhad has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 5.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We also note that Hubline Berhad improved its EBIT from a last year's loss to a positive RM6.6m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hubline 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, a company can only pay off debt with cold hard cash, not accounting profits. 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, Hubline 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

Mulling over Hubline Berhad's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Looking at the bigger picture, it seems clear to us that Hubline Berhad's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Hubline Berhad you should be aware of, and 2 of them shouldn't be ignored.

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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