These 4 Measures Indicate That Tri-Mode System (M) Berhad (KLSE:TRIMODE) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Tri-Mode System (M) Berhad (KLSE:TRIMODE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tri-Mode System (M) Berhad

How Much Debt Does Tri-Mode System (M) Berhad Carry?

As you can see below, Tri-Mode System (M) Berhad had RM39.0m of debt at March 2023, down from RM44.1m a year prior. However, it also had RM17.8m in cash, and so its net debt is RM21.1m.

How Healthy Is Tri-Mode System (M) Berhad's Balance Sheet?

We can see from the most recent balance sheet that Tri-Mode System (M) Berhad had liabilities of RM14.6m falling due within a year, and liabilities of RM40.9m due beyond that. On the other hand, it had cash of RM17.8m and RM13.9m worth of receivables due within a year. So its liabilities total RM23.8m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Tri-Mode System (M) Berhad has a market capitalization of RM60.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tri-Mode System (M) Berhad has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 2.5 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Investors should also be troubled by the fact that Tri-Mode System (M) Berhad saw its EBIT drop by 13% over the last twelve months. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Tri-Mode System (M) 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Tri-Mode System (M) Berhad's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Tri-Mode System (M) Berhad's EBIT growth rate and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Once we consider all the factors above, together, it seems to us that Tri-Mode System (M) Berhad's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 Tri-Mode System (M) Berhad .

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. 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.