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The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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. As with many other companies Wong Engineering Corporation Berhad (KLSE:WONG) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Wong Engineering Corporation Berhad
What Is Wong Engineering Corporation Berhad’s Net Debt?
The image below, which you can click on for greater detail, shows that Wong Engineering Corporation Berhad had debt of RM16.2m at the end of January 2021, a reduction from RM18.2m over a year. But on the other hand it also has RM22.7m in cash, leading to a RM6.49m net cash position.
How Healthy Is Wong Engineering Corporation Berhad’s Balance Sheet?
The latest balance sheet data shows that Wong Engineering Corporation Berhad had liabilities of RM20.5m due within a year, and liabilities of RM14.3m falling due after that. Offsetting this, it had RM22.7m in cash and RM26.6m in receivables that were due within 12 months. So it can boast RM14.4m more liquid assets than total liabilities.
This surplus suggests that Wong Engineering Corporation Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Wong Engineering Corporation Berhad boasts net cash, so it’s fair to say it does not have a heavy debt load!
Fortunately, Wong Engineering Corporation Berhad grew its EBIT by 5.1% in the last year, making that debt load look even more manageable. 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 Wong Engineering Corporation Berhad will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Wong Engineering Corporation Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Wong Engineering Corporation Berhad actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While it is always sensible to investigate a company’s debt, in this case Wong Engineering Corporation Berhad has RM6.49m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 132% of that EBIT to free cash flow, bringing in RM5.4m. So is Wong Engineering Corporation Berhad’s debt a risk? It doesn’t seem so to us. 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 4 warning signs we’ve spotted with Wong Engineering Corporation Berhad .
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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