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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Swang Chai Chuan Limited (HKG:2321) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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.
Check out our latest analysis for Swang Chai Chuan
What Is Swang Chai Chuan's Debt?
You can click the graphic below for the historical numbers, but it shows that Swang Chai Chuan had RM37.2m of debt in June 2024, down from RM63.1m, one year before. However, it does have RM62.4m in cash offsetting this, leading to net cash of RM25.2m.
How Healthy Is Swang Chai Chuan's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Swang Chai Chuan had liabilities of RM99.0m due within 12 months and liabilities of RM24.8m due beyond that. Offsetting these obligations, it had cash of RM62.4m as well as receivables valued at RM139.6m due within 12 months. So it actually has RM78.2m more liquid assets than total liabilities.
This surplus strongly suggests that Swang Chai Chuan has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Swang Chai Chuan boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Swang Chai Chuan if management cannot prevent a repeat of the 27% cut to EBIT 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 you can't view debt in total isolation; since Swang Chai Chuan 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Swang Chai Chuan has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Swang Chai Chuan created free cash flow amounting to 7.9% 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 Swang Chai Chuan has net cash of RM25.2m, as well as more liquid assets than liabilities. So we don't have any problem with Swang Chai Chuan's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Swang Chai Chuan .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.