We Think Tri-Mode System (M) Berhad (KLSE:TRIMODE) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Tri-Mode System (M) Berhad (KLSE:TRIMODE) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

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

What Is Tri-Mode System (M) Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Tri-Mode System (M) Berhad had RM44.1m of debt, an increase on RM27.7m, over one year. However, because it has a cash reserve of RM10.6m, its net debt is less, at about RM33.5m.

A Look At Tri-Mode System (M) Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Tri-Mode System (M) Berhad had liabilities of RM25.1m due within 12 months and liabilities of RM42.7m due beyond that. Offsetting this, it had RM10.6m in cash and RM26.5m in receivables that were due within 12 months. So its liabilities total RM30.6m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Tri-Mode System (M) Berhad is worth RM77.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Tri-Mode System (M) Berhad has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 3.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Tri-Mode System (M) Berhad grew its EBIT a smooth 34% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept 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, Tri-Mode System (M) Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Tri-Mode System (M) Berhad's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Tri-Mode System (M) Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 be aware of the 2 warning signs we've spotted with Tri-Mode System (M) 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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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.