Solution Group Berhad (KLSE:SOLUTN) seems to be using debt quite wisely
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We notice that Berhad Solutions Group (KLSE:SOLUTN) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Solution Group Berhad
What is Solution Group Berhad’s debt?
The image below, which you can click on for more details, shows that as of September 2021, Berhad Solutions Group had debt of RM32.6m, up from RM6.47m in one year . However, since he has a cash reserve of RM24.8 million, his net debt is less at around RM7.88 million.
How healthy is Solution Group Berhad’s balance sheet?
The latest balance sheet data shows that Solution Group Berhad had liabilities of RM82.4 million due within one year, and liabilities of RM5.76 million falling due thereafter. In return, he had RM24.8 million in cash and RM22.9 million in receivables due within 12 months. Thus, its liabilities total RM40.4 million more than the combination of its cash and short-term receivables.
Of course, Solution Group Berhad has a market capitalization of RM241.7 million, so these liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Solution Group Berhad’s net debt is 3.3 times its EBITDA, which represents significant but still reasonable leverage. However, its interest coverage of 1k is very high, suggesting that debt interest charges are currently quite low. Notably, Solution Group Berhad’s EBIT launched higher than Elon Musk, gaining 791% from a year ago. When analyzing debt levels, the balance sheet is the obvious starting point. But it is Solution Group Berhad’s earnings that will influence the balance sheet going forward. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past two years, Solution Group Berhad has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
The conversion of EBIT to free cash flow by Solution Group Berhad was a real negative in this analysis, even though the other factors we considered were considerably better. In particular, we are dazzled by its interest coverage. When considering all the elements mentioned above, it seems to us that Solution Group Berhad manages its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Solution Group Berhad displays 3 warning signs in our investment analysis and 1 of them is a little unpleasant…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.