Lingkaran Trans Kota Holdings Berhad (KLSE:LITRAK) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Lingkaran Trans Kota Holdings Berhad (KLSE:LITRAK) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Lingkaran Trans Kota Holdings Berhad

What Is Lingkaran Trans Kota Holdings Berhad's Debt?

As you can see below, Lingkaran Trans Kota Holdings Berhad had RM583.0m of debt at September 2020, down from RM777.8m a year prior. However, because it has a cash reserve of RM436.7m, its net debt is less, at about RM146.2m.

A Look At Lingkaran Trans Kota Holdings Berhad's Liabilities

We can see from the most recent balance sheet that Lingkaran Trans Kota Holdings Berhad had liabilities of RM231.7m falling due within a year, and liabilities of RM603.9m due beyond that. On the other hand, it had cash of RM436.7m and RM190.9m worth of receivables due within a year. So its liabilities total RM207.9m more than the combination of its cash and short-term receivables.

Since publicly traded Lingkaran Trans Kota Holdings Berhad shares are worth a total of RM2.09b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Lingkaran Trans Kota Holdings Berhad has a low net debt to EBITDA ratio of only 0.37. And its EBIT easily covers its interest expense, being 10.3 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Lingkaran Trans Kota Holdings Berhad's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lingkaran Trans Kota Holdings Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Lingkaran Trans Kota Holdings Berhad recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Lingkaran Trans Kota Holdings Berhad's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its EBIT growth rate has the opposite effect. We would also note that Infrastructure industry companies like Lingkaran Trans Kota Holdings Berhad commonly do use debt without problems. When we consider the range of factors above, it looks like Lingkaran Trans Kota Holdings Berhad is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. To that end, you should be aware of the 2 warning signs we've spotted with Lingkaran Trans Kota Holdings Berhad .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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