Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hubline Berhad (KLSE:HUBLINE) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Hubline Berhad Carry?
As you can see below, Hubline Berhad had RM38.7m of debt at September 2020, down from RM73.3m a year prior. On the flip side, it has RM33.6m in cash leading to net debt of about RM5.18m.
How Strong Is Hubline Berhad's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hubline Berhad had liabilities of RM119.0m due within 12 months and liabilities of RM62.2m due beyond that. On the other hand, it had cash of RM33.6m and RM13.5m worth of receivables due within a year. So its liabilities total RM134.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of RM195.0m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hubline Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Hubline Berhad reported revenue of RM135m, which is a gain of 8.6%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Importantly, Hubline Berhad had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost RM7.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled RM11m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Hubline Berhad has 3 warning signs (and 1 which is concerning) we think you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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