KGW Group Berhad (KLSE:KGW) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that KGW Group Berhad (KLSE:KGW) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 KGW Group Berhad

How Much Debt Does KGW Group Berhad Carry?

As you can see below, KGW Group Berhad had RM7.78m of debt at June 2024, down from RM18.5m a year prior. However, it does have RM24.5m in cash offsetting this, leading to net cash of RM16.7m.

How Strong Is KGW Group Berhad's Balance Sheet?

We can see from the most recent balance sheet that KGW Group Berhad had liabilities of RM19.7m falling due within a year, and liabilities of RM6.31m due beyond that. Offsetting this, it had RM24.5m in cash and RM17.8m in receivables that were due within 12 months. So it actually has RM16.2m more liquid assets than total liabilities.

This excess liquidity suggests that KGW Group Berhad is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that KGW Group Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that KGW Group Berhad's load is not too heavy, because its EBIT was down 83% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is KGW Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. KGW Group 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. In the last three years, KGW Group Berhad created free cash flow amounting to 9.7% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that KGW Group Berhad has net cash of RM16.7m, as well as more liquid assets than liabilities. So we don't have any problem with KGW Group Berhad's use of debt. 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. To that end, you should learn about the 5 warning signs we've spotted with KGW Group Berhad (including 2 which make us uncomfortable) .

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.