Stock Analysis

These 4 Measures Indicate That Envictus International Holdings (SGX:BQD) Is Using Debt In A Risky Way

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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.' 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. Importantly, Envictus International Holdings Limited (SGX:BQD) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Envictus International Holdings

What Is Envictus International Holdings's Net Debt?

As you can see below, Envictus International Holdings had RM205.3m of debt at September 2022, down from RM268.1m a year prior. On the flip side, it has RM29.0m in cash leading to net debt of about RM176.3m.

SGX:BQD Debt to Equity History February 3rd 2023

How Strong Is Envictus International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Envictus International Holdings had liabilities of RM212.3m falling due within a year, and liabilities of RM216.0m due beyond that. Offsetting this, it had RM29.0m in cash and RM52.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM347.1m.

The deficiency here weighs heavily on the RM138.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Envictus International Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.16 times and a disturbingly high net debt to EBITDA ratio of 5.9 hit our confidence in Envictus International Holdings like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Envictus International Holdings achieved a positive EBIT of RM3.2m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Envictus International Holdings will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Envictus International Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Envictus International Holdings's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Envictus International Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for Envictus International Holdings (1 shouldn't be ignored) you should be aware of.

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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